HG 

^973 

ri92v 


iversity  of  Californj 
Southern  Regional 
Library  Facility 


maNVMjv 


'</iiUAINllJV\> 


'WAflvattiri*' 


'WAOVoaira*' 


'•lUJUl  JUI    ' 


iFCAllFOff^      ^OF-CAllF0/?/j|^ 


j^\\^El)NI\f!R% 


^lOSANCElfT^ 
o 


5^1-UBRARYQ^      ^ 


'^J^UONVSOl'^ 


"^AaaAiNrt-aVkV^      ^,!/ojnvjio^    ^ 


\WEUNIVERS/A       ^lOSANCElfx>, 


'^i:/133NVS01'^ 


%a3AiNa-3V^^ 


^OFCAIIFO^, 


^4r     k 


>&AavaaiH^ 


\vmmih 


% 


f 


^ElimVERS'//v 


c5 


f 

133NVS01^ 


^10SANCEI% 


'^Aa3AiNn-3V«^ 


^lOSANCEl^^ 

CO 


^aaAiNftJViV 


-^lUBRARYOr, 


^OFCAllFORil^ 


^^tUBRARYQ^ 


^OFCAllFOff^i^ 


IMEUNIVERJ/A 


"^^Aavaan-^ 


"^(^AHvaan-^ 


"^XiUONVSOl^ 


.^WEUNIVERJ//^ 


■UBRARYQ^^ 


jfOJllVDJO^ 
iF-CAllFO/?,il^ 


[Aavaaii#' 


Kj^HIBRARYQ^ 


^OF-CAIIFO/?^ 


^^Aavaan-1^ 


5^5ji^EUNIVER%. 


^5jt\EUNIVER% 


^lOS-ANCEl^* 

o  A      /I""™  c= 

CO 


^lOSANCElfX^ 
o 


-«>^tUBRARY<9/;^ 


^XiUONVSOl'^       '%jeVINIl-3WV 


■^/iiGAlNflavW^         \Qi\mi^^ 


^OFCAllFOff/i^ 


"^^JAavaaii-^^ 


EUNIVERS"//) 


% 


o 

|?H3NVS01^ 
\EDNIVERy/A 


>^lOSANCElf/^ 
o 


.vS:lOSANCElfx> 


^tUBRARYO^, 
^  1   ir^  •£■ 


^.QFCALIFOff/fe, 


^lUBRARYQr^ 
§  1   ir^  ^ 


,^.OF•CAUF0/?^^ 


,5MEUNIVERy/A. 


ea 


ameuniver% 


The  Value  of  a 

Railroad  Security 


By 
FLOYD  W.  MUNDY,  A.B. 


Member,  Chicago  Stock  Exchange.      Partner,  James  H.  Oliphant 

&  Company,  Members  of  New  York  Stock  Exchange.     Lecturer 

on  Railroad  Securities,  Finance  Forum.     Author,  "  The  EarninJ^ 

Power  of  Railroads,"  "  Financial  Pyramiding,"  etc. 


AMERICAN  INSTITUTE  OF  FINANCE 
BOSTON 


A 


"COMPLETE  EDUCATIONAL  COURSE" 

IN  THE  SCIENCE  OF 

MAKING  MONEY  MAKE  MORE  MONEY 

This  list  is  arranged  in  the  order  of  proper  reading.  The 
books  are  accompanied  by  a  series  of  test  questions,  key  prob- 
lems and  analyses  outlines,  enabling  the  student  to  apply  the 
knowledge  acquired  to  immediate  stock  market  and  investment 
conditions. 

L  Developing  Financial  Skill      H.  Investment  Senirities 
2.  Forces  Which  Make  Prices      12.  Business  Cycles 


3.  Manipulation  and  Market      1^-  Measuring   and    Forecasting 

General   Business    Condi- 
tions 


Leadership 


4.  Handling  a  Brokerage  Ac- 

count 

5.  Market  Information 

6.  The  Essential  Features  of 

Securities 

7.  The   Value  of  a  Railroad 

Security. 

8.  Industrial  Securities 

9.  Oil  Securities 

10.  Mining  Securities . 


14.  The  Technical  Position  of  the 

Market 

15.  Money  and  Credit 

16.  Business  Profits 

17.  Launching  a  New  Enterprise 

18.  Securing   Capital  for  Estab- 

lished Enterprise 

19.  Internal  Financial   Manage- 

ment 

20.  Search  for  Bargains 


Copyright.  1922.  by 
American  Institute  of  Finance 


.y^ 


TABLE  OF  CONTENTS 

Chapter  I.     "Which  is  Which?"  Page 

Underlying  Considerations 5 

Essentials  in  the  Railroad  Problem 6 

Position  df  the  Labor  Unions 6 

^                 Activities  of  the  Financial  Interests 7 

s.                    Methods  of  Operation 8 

,                   Financial  Pyramiding 9 

rt^                  Interest  of  Security  Owners 10 

\                  False,  or  Misleading,  Representations 11 

|s.                  Position  of  the  Investor 11 

-\                  Present  Outlook 12 

Market  Prospects 13 


Chapter  II.     The  Use  of  Statistics 

The  Basis  of  Value IS 

Correct  Use  of  Statistics 16. 

Railroad  Reports 17 

Uniformity  of  Reports 18; 

Accounting  Regulations  of  Interstate  Commerce  Commission      .      .  1& 

Chapter  III.     Income  Account 

Items  Included 20 

Classification  and  Terms  Used 20 

What  Income  Account  Covers 21 


Chapter  IV.     Operating  Expenses 

Seven  General  Accounts 23 

Explanation  of  Accounts 23 

How  Accounts  are  Grouped 24 

4 

Significance  to  Investors 26 

What  Analysis  Will  Show 26 


'^^"^      Chapter  V.     Maintenance  Expenses 


X 


^^^A     Chapter  VI.     Maintenance  of  Way 

^V^  Using  the  "Per  Mile"  Basis 28 

^^^  Comparisons  and  Qualifications 28 

Reasons  for  Increase 29 

Ruling  of  the  Commission 30 

Depreciation  of  Fixed  Improvements 30 


447468 


4  Table   of   C  oil  ten  t  s 

Chapter  \'II.     Maintenance  of  Equipment  Page 

Tests  to  Apply 31 

Normal  Maintenance  Requirements 32 

Equipment  Depreciation  Ruling 33 

Depreciation  Rates 33 

Charging  and  Crediting  Depreciation  Reserve 34 

Various  Roads'  Expenditures 35 

Chapter  VIII.     Traffic  and  Transportation  Expenses,  Mis- 
cellaneous Operations,  Etc. 

Nature  of  these  Expenses 37 

Essentials  to  Consider 37 

Two  Roads  Compared         38 

General  Rule 39 

Chapter  IX.     The  Operating  Ratio 

Has  It  Significance? 41 

"Rules,"  with  Qualifications 43 

Chapter  X.     Fixed  Charges 

Suggested  Examinations 44 

Significance  of  Item 45 

Fixed  Charges  as  an  Investment  Test 45 

•Comparison  of  Two  Railroads 46 

Chapter  XI.     Stock  Outstanding  in  Its  Relation  to  Earning 
Power 

Integrity  of  Net  Earnings  and  Surplus 49 

Margin  of  Safety 50 

Earning  Power 51 

Financing  Policies 51 

Basis  of  Earning  Power 52 

Chapter  XII.     Concluding  Observations 

What  May  Readily  be  Gained? 53 

What  Must  be  Emphasized? 54 

Is  New  Era  Dawning? 54 

Future  Possibilities 55 

Test  Questions 

Analysis  Outline 

Key  Problem 


CHAPTER    I 
"WHICH    IS  WHICH?" 

"  Until  the  investor's  interest  is  accorded  just  and  jitll 
consideration,  regulation  cannot  hope  to  attain  its  own  set 
purpose  and  proper  aim,  which  is  the  attainment  of  an 
adequate  public  service  at  reasonable  rates y 

W^ILLIAAr    Z.     RiPLEV, 

Professor  of  Economics,  Harvard  University. 

Underlying  Considerations 

Railroad  securities,  notably  railroad  bonds,  have  for  many 
years  enjoyed  the  favor  of  investors,  for  reasons  which  are  well 
established.  For  over  half  a  century  of  the  greatest  period^of 
development  which  any  nation  has  ever  witnessed,  the  railroads 
of  the  United  States  have  proved  themselves  to  be  not  only  the 
pioneers  in  the  opening  and  developing  of  new  territory,  but 
also  the  main  arteries  for  the  constantly  increasing  commerce 
of  the  nation.  In  railroad  securities,  more  than  in  any  other 
form  of  corporate  security,  are  to  be  found  the  elements  which 
make  for  stability  in  value.  The  railroads  have  proved  them- 
selves necessary  to  the  development  of  the  nation  and  are 
directly  related  to  public  necessity  and  convenience. 

The  railroad  companies,  as  the  employers  of  so  large  a  number 
of  the  laborers  of  the  nation,  are  protected  in  that  the  prosperity 
of  each  is  closely  related.  Further  security  is  found  in  the  fact 
that  so  great  a  proportion  of  the  wealth  of  the  nation  is  invested 
in  the  securities  of  the  railroads.  Perhaps  the  greatest  safeguard 
protecting  railroad  securities  is  found  in  the  cost  of  the  railroads 
themselves  and  the  impossibility  of  replacing  them.  It  is 
commonly  known  that  the  terminals  alone  in  the  large  com- 
mercial centers  of  the  country  are  not  capable  of  being  duplicated, 
irrespective    of    the    cost    involved.     Furthermore,  it    appears 


6  A    Railroad  Security 

highly  improbable  that  any  new  invention  in  the  aid  of  trans- 
portation will  be  discovered  which  will  not  readily  adapt  itself 
to  the  steam  railroad  of  today. 

These  underlying  considerations  merit  emphasis  at  the  begin- 
ning of  this  discussion  in  view  of  the  current  controversies 
which  surround  railroads  and  the  wide-spread  apprehension 
which  has  seized  upon  investors  in  rail  securities. 

Essentials  in  the  Railroad  Problem 

What  are  the  essential  elements  concerning  a  railroad  which, 
when  analyzed,  afford  clearer  insight  into  its  earnings  and  a 
more  accurate  estimate  of  the  value  of  its  securities? 

The  railroad's  business  is  to  supply  transportation,  which 
requires  a  property  —  roadbed,  rolling  stock,  terminals,  etc. — 
and  a  management  which  directs  its  operations.  The  funds 
required  can  be  derived  from  two  sources,  rates  charged  shippers 
and  capital  supplied  by  investors. 

This  appears  simple  enough.  But  other  elements  represent 
interests  often,  if  not  always,  in  opposition. 

Shippers  have  naturally  desired  low  rates,  and  they  have 
not  hesitated  to  press  their  claims  vigorously,  and  at  times 
unscrupulously,  before  State  and  Federal  Commissions  and 
legislative  bodies  when  rates  and  rate  changes  were  under 
consideration.  Public  opinion,  for  reasons  which  become  clearer 
as  we  proceed,  has  been  apathetic,  if  not  openly  hostile,  toward 
the  claims  of  the  railroads.  Hence  inroads  have  been  made  in 
this  way  upon  earnings. 

Labor  has  likewise  pressed  its  claims.  The  employes  on 
our  railroads  have  been,  as  compared  with  other  industries, 
highly  unionized. 

Position  of  the  Labor  Unions 

As  a  result  of  the  highly  organized  state  of  railroad  labor 
unions  in  this  country  they,  or  their  representatives,  have 
taken  a  much  larger  interest  in  the  operating  and  linancial 
problems  than  has  labor  in  perhaps  any  other  industry. 


"  Which   is    Which?"  7 

Their  very  highly  organized  state  gave  them  great  power 
during  the  war.  It  brought  rapid  wage  advances,  although  it 
must  be  said  that  the  advances  in  this  industry  did  not  compare 
with  those  in  the  building  or  manufacturing  industry.  Where 
organization  did  count,  however,  was  in  the  post-war  readjust- 
ment. The  labor  unions  contended  that  reductions  in  wages 
should  be  accompanied  or  preceded  by  reductions  in  rates  which 
would  have  a  material  effect  in  lowering  living  costs. 

This  strongly  entrenched  position  of  the  labor  unions  has 
brought  forth  much  criticism.  The  whole  situation  should  be 
looked  at  with  a  broad  mind,  however.  It  is  not  true  that  labor 
has  no  interest  in  the  success  and  failure  of  our  railroads,  as  has 
been  often  stated.  The  plan  of  railroad  operation  brought 
forth  by  the  railroad  unions,  the  "Plumb  Plan"  likewise  cannot 
be  condemned  as  a  whole.  It  has  weak  points  and  strong  points 
just  as  has  the  Esch-Cummins  Bill.  Some  of  its  principles 
will  doubtless  be  carried  out  in  the  consolidations  and  mergers 
of  the  next  two  to  five  years. 

While  railroad  unions  have  held  up  Congress  and  the  public 
in  an  attempt  to  enforce  their  demands  this  cannot  be  said  to 
have  been  any  worse  than  the  attitude  assumed  by  the  financial 
interests  toward  such  railroad  organizations  as  the  New  York, 
New  Haven  &  Hartford,  the  St.  Louis-San  Francisco,  and  other 
minor  properties.  The  attitude  of  the  railroad  executive  in 
their  dealings  with  the  labor  unions  has  given  rise  to  the  general 
understanding  that  the  interests  of  the  two  are  mutually  an- 
tagonistic. This  is  one  of  the  situations  that  has  got  to  be  ironed 
out  in  the  next  few  years  before  the  railroads  can  once  more 
resume  a  sound  position. 

Activities  of  the  Financial  Interests 

The  financial  interests  have  not  been  less  active,  and  often- 
times not  less  selfish  and  narrow,  than  the  shippers  and  the 
labor  unions. 

The  establishment  by  the  railroads  during  the  past  decade 
of  the  community  of  interest  principle  has  resulted  in  the  redis- 
tribution of  ownership,  in  furtheranceof  which,  scores  of  millions 


8  A    Railroad   Security 

of  dollars  of  stocks  of  railroads  have  been  acquired  by  or  in  the 
interest  of  large  systems.  This  movement  likewise  has  resulted 
in  the  creation  of  scores  of  millions  of  bonds  and  other  forms  of 
indebtedness,  including  collateral  trust  bonds,  guaranteed 
certificates,  etc.  The  railroads  of  this  country,  have  in  large 
measure  been  rebuilt  during  the  past  ten  or  fifteen  years,  and 
their  physical  and  financial  rehabilitation  has  called  for  the 
application  of  vast  sums,  which  again  has  necessitated  the 
selling  of  hundreds  of  millions  of  new  securities  of  existing 
railroads. 

It  is  not  unnatural  that,  during  this  period  of  extensive 
financing,  many  millions  of  securities  have  been  issued  without 
justification  so  far  as  relates  to  existing  values  or  earning  capacity. 
High  finance  operations,  or  it  might  better  be  termed,  low  finance 
operations,  have  been  followed  by  financial  scandals. 

Methods  of  Operation 

The  development  of  the  conditions  described  above  has  been 
possible  in  this  country  because  of  the  fact  that  the  railroads, 
public  carriers  of  passengers  and  goods,  have  been  under  the 
control  of  a  relatively  few  large  stockholders.  In  the  past 
twenty  years  railroad  securities  have  become  more  widely  held 
by  investors  than  probably  any  other  type  of  security  issues. 
Although  each  stockholder  is  entitled  to  a  vote  at  the  meetings 
of  the  corporation,  this  prerogative  is  seldom  exercised.  A 
concentrated  ownership  of  not  over  10%  to  15%  of  the  total 
outstanding  capitalization  allows  undisputed  control  of  the 
property. 

Under  such  conditions,  with  the  interlocking  directorates 
of  the  past,  it  has  been  possible  for  large  financial  interests, 
through  very  little  actual  ownership  of  stock,  to  control  the 
operations  of  practically  all  our  large  railroad  systems.  This 
has  naturally  brought  with  it  misuse  of  the  power  invoked 
and  has  caused  many  railroad  wrecks  where,  under  careful 
management,  successful  operation  could  have  been  maintained 
without  trouble. 

In  perhaps  the  majority  of  cases  the  difficulties  have  been 


"  Which   is    Which?"  9 

brought  about  by  loading  down  railroad  systems  with  un- 
profitable branches,  feeders,  or  other  types  of  carriers  such  as 
street  railways,  for  example.  The  case  of  the  St.  Louis-San 
Francisco  is  interesting.  This  company  through  the  early 
1900's  persisted  in  issuing  bond  issue  after  bond  issue  for  the 
purpose  of  expanding  and  buying  branch  roads,  which,  pre- 
sumably, were  bought  from  interests  close  to  the  company  at 
prices  considerably  in  excess  of  what  had  originally  been  paid 
for  them.  Under  gradually  advancing  commodity  and  wage 
prices  these  newly  acquired  properties  were  unable  to  earn  a 
satisfactory  return  on  the  inflated  values  that  had  been  placed 
on  them.  The  net  result  was  to  place  the  entire  system  in 
receivership  —  a  system  having  tremendous  possibilities  in 
itself,  if  left  alone;  running  through  the  most  fertile  and  perhaps 
the  most  promising  region  in  the  United  States. 

The  N.  Y.,  N.  H.  &  Hartford  R.  R.  is  another  illustration  of 
similar  tactics,  although  in  a  different  situation.  Here  was  a 
road  with  a  relatively  short  haul,  tapping  the  densest  industrial 
section  of  the  United  States  up  to  the  war  period.  Those  in 
control,  not  satisfied  with  a  smoothly  operated  property  —  the 
stock  of  which  had  risen  to  above  $200  a  share  —  set  about  to 
control  the  entire  railroad  situation  in  New  England.  This 
control  was  based  on  not  only  steam  railroad  operations  but 
electric  railway  operations  as  well.  It  was  evidently  thought 
that  almost  any  price  could  be  paid  for  such  additional  railroads 
and  electric  railways  and,  on  account  of  economies  of  consolida- 
tion, a  good  return  still  be  earned  on  them  —  at  least  sufficient 
to  satisfy  public  ethics.  This  scheme,  however,  ran  up  against 
a  rapidly  growing  commission  control  of  public  utilities.  The 
high  finance  involved  in  its  operation  brought  a  top-heavy 
capitalization,  resulting  in  receivership  of  many  subsidiaries  and 
the  financial  decline  of  the  New  Haven  itself. 


Financial  Pyramiding 

Small  groups  of  capitalists  are  frequently  found  to  control, 
through  a  relatively  small  investment  of  capital,  large  systems  of 


10  A    RailroadSecurity 

railroads  where  scores  of  millions  of  dollars  of  bonds  of  such 
railroads  are  placed  in  the  hands  of  bona  fide  investors  who  have 
no  protection  against  reckless  financing  or  imprudent  manage- 
ment on  the  part  of  the  small  group  in  control,  although  such 
may  result  in  the  impairment  of  the  safety  of  their  investments. 
The  amount  actually  invested  in  a  railroad  might  be  Si  10,000,000, 
represented  in  securities  by  510,000,000  of  stock  and  $100,000,000 
of  bonds  and  other  fixed-interest  but  non-voting  securities,  and 
not  only  the  market  value  but  also  the  intrinsic  value  of  the 
$100,000,000  of  non-voting  securities,  might  be  placed  in  jeopardy 
by  the  high  finance  operations  of  a  few  who  own  control  of  the 
$10,000,000  of  capital  stock. 

This  kind  of  pyramiding  is  like  trading  on  a  slim  margin,  so 
far  as  the  stockholders  are  concerned. 


Interest  of  Security  Owners 

The  capitalization  of  our  railroads  is  roughly  $20,000,000,000 
of  which  somewhat  over  $12,000,000,000  consists  of  bonds,  or 
three-fifths.  As  long  as  interest  is  paid  on  bonds  or  notes,  the 
bond  or  noteholder  has  no  voice  in  the  management  of  a 
company.  It  is  entirely  in  the  hands  of  stockholders.  As  we 
have  shown  above,  on  account  of  the  concentration  of  financial 
control  of  our  large  railroad  systems  converging  in  the  hands 
of  a  few,  these  few  controlled  operations  as  a  whole. 

Out  of  the  developments  of  the  past  few  years,  and  the 
resulting  attempts  to  put  our  railroads  on  a  sound  foundation, 
bondholders  have  been  forced  to  take  cognizance  ot  the  situation 
outlined  above.  The  result  has  been  the  formation  of  what  has 
been  known  as  the  Security  Owners  Association.  This  Asso- 
ciation is  a  voluntary  one,  joined  by  railroad  bond  and  note- 
holders throughout  the  country.  It  has  as  its  off.cers  some  of 
the  men  in  this  country  who  have  given  much  thought  to  railroad 
problems  and  who  are  now  taking  an  active  discussion  and 
participation  in  the  proposed  financial  schemes  to  rehabilitate 
roads.     This  increased  interest  augurs  well  for  the  future. 

If  we  are  to  place  our  railroad  industry  on  a  stable  foundation 


"  Which   is    Which?''  11 

all  those  interested  from  a  financial,  service,  or  employment 
standpoint,  must  get  together.  No  solution  will  be  found 
favoring  one  group  at  the  expense  of  the  others. 

False,  or  Misleading,  Representations 

Bankers,  both  of  large  and  small  reputation,  have  repeatedly 
placed  bonds  in  the  hands  of  investors  through  issuing  circulars 
which  are  misleading,  to  say  the  least.  It  is  true  that  reliance  is 
placed  on  the  high  standing  of  some  of  the  banking  firms  and  the 
investor  is  protected  to  the  extent  that  these  firms  would  not 
offer  for  sale,  securities  which  they  did  not  believe  to  be  safe  as 
to  principal  and  interest.  While  the  representations  made  in 
the  circulars  are  usually  quoted  from  statements  made  by  officers 
of  the  railroad  companies  and  are  based  largely  on  facts,  and 
where  figures  are  given  only  facts  are  stated,  nevertheless  the 
facts  presented  repeatedly  convey  an  entirely  false  impression 
as  to  the  investment  merit  of  the  bonds,  and  the  bankers  them- 
selves must  know  that  the  circulars  are  misleading. 

These  practices,  particularly  the  more  glaring  examples  of 
high  finance  like  "Rock  Island"  and  "Frisco,"  have  aroused 
distrust  necessarily.  And  the  old  policy  of  secrecy,  under  w^hich 
only  such  information  was  furnished  as  was  legally  necessary, 
served  to  strengthen  this  distrust  and  leave  the  public  mind 
susceptible  to  catch-penny  phrases,  slogans,  and  by-words. 
Every  demagogue  and  yellow  journal  which  chose  to  attack 
corporations  has  fed  the  phrase  "water-stock,"  for  instance, 
to  the  unthinking,  who  accepted  it  at  face  value  and  applied  it 
to  all  railroads  alike.  Thus  did  the  odium  pertaining  to  certain 
financial  mispractices  come  to  attach  itself,  more  or  less,  to  all 
railroads. 

Position  of  the  Investor 

These  well  organized  and  persistent  activities  of  shippers, 
labor  unions  and  financial  interests  have  at  times  so  engrossed 
attention  that  the  important  functions  and  rightful  claims  of 
the  investor  have  been  all  but  lost  sight  of.     The  inv^estor's 


12  A    Railroad  Security 

interests  are  neglected  in  this  matter,  it  seems  to  me,  on  the 
theory,  I  presume,  that  the  investor  is  of  mature  age  and  can 
care  for  himself;  being  expected  to  consider  what  comes  to  him 
as  inevitably  his  just  desserts  because  of  the  fact  that  the  invest- 
ment of  funds  is  by  no  means  an  exact  science. 

More  specifically,  much  of  the  injustice  and  deception 
practiced  upon  investors  and  the  losses  which  occur  can  be 
traced  to  several  prominent  causes,  as  follows: 

1.  The  shortsightedness  of  the  public,  shippers,  and  unions. 

Methods  have  been  employed  by  these  groups  which 
defeat  their  own  best  interests  viewed  broadly. 

2.  The  inelastic  system  of  regulation  enforced  b}'  the  Inter- 

state Commerce  Commission.  Failure  to  take  account 
of  increased  transportation  needs,  due  to  the  country's 
growth,  and  to  mounting  costs  in  consequence  of  world- 
wide changes  outside  of  railroad  control,  are  two  specific 
ways  in  which  this  inelasticity  has  been  shown. 

3.  Directors    or    Trustees    frequently    have    not    performed 

their  fiduciary  duties.  This,  in  the  final  analysis  of 
railroad  development,  may  prove  to  have  been  the 
most  important. 

4.  Stockholders   fail   often-times   to   take  sufficient  personal 

interest  in  the  affairs  of  their  companies. 

5.  The   change   in   economic   conditions  which   altered   the 

prices  of  capital  and  hence  reduced  the  prices  of  fixed 
interest-bearing  securities  from  1900  to  1920. 

6.  Investors  generally  are  guilty  of  too  great  cupidity  and 

ignorance  in  the  matter  of  investments  and  thus  become 
easy  prey  for  self-seeking  or  unscrupulous  financiers. 

Present  Outlook 

What  has  been  said  so  far  indicates  the  causes  for  the  wide 
spread  apprehension  of  investors  in  railroad  securities.  But 
their  recital,  involving  as  it  does  dark  chapters  of  labor  intrigue 
and  financial  piracy,  must  not  be  allowed  to  obscure  the  under- 


"  Which   is    Which?''  13 

lying  considerations  with  which  this  discussion  commenced  — 
the  basic  importance  of  railroad  service  and  the  solid  values 
behind  railroad  securities.  Particularly  is  this  the  case  at 
present. 

Will  the  railroads  come  back?  Will  their  securities  again 
become  the  chief  medium  of  investment  for  the  conservative? 
What  does  the  future  promise  the  railroads  or  the  public? 

These  questions  embody  what  is  back  in  the  minds  of  a 
vast  army  of  investors  directly  or  indirectly  interested  in 
railroad  securities.  The  business  of  manufacturing  transporta- 
tion is  no  longer  an  experiment;  it  now  approaches  the  exactness 
of  a  science.  Railroads  have  passed  through  successive  stages 
of  organization,  development,  consolidations,  exploitations, 
wreckings  —  all  of  which  has  finally  led  to  standardization. 
Every  road  possesses  a  natural  monopoly  in  the  traffic  of  the 
territory  it  serves.  That  business  is  guaranteed,  not  for  today, 
not  for  this  year,  but  for  all  time;  and  furthermore,  there  is  a 
promise  there  will  be  an  increase  in  traffic  proportionate  to  the 
growth  of  population  and  trade  of  these  United  States. 

The  public  has  come  to  appreciate  with  some  degree  of 
vividness  the  importance  of  transportation,  and  its  essential 
costs;  so  much  so  that  one  may  claim  with  right  that  the  investor 
has  become  at  length  a  party  in  interest.  Recent  legislation 
places  him  upon  a  decidedly  more  substantial  basis.  Perhaps 
it  may  not  be  too  strong  to  say  it  will  emancipate  him. 

This  recognition  of  his  functions  and  rightful  claims  enables 
the  investor  to  face  the  future  with  increased  assurance.  But, 
'in  addition,  it  affords  him  excellent  opportunities  for  the  exercise 
of  foresight  in  his  selection  of  railroad  securities.  « 

Market  Prospects 

In  the  stock  market,  financial  and  commercial  leaders  of  this 
great  country  register  continuously,  in  terms  of  dollars  and 
cents,  their  estimate  of  the  importance  of  the  influence  of  coming 
events  upon  general  business.  This  estimate  is  founded  not 
alone  upon  financial  and  commercial  facts,  actual  or  anticipated, 


14  A    Railroad  Security 

but  also  based  upon  the  interpretation  by  these  men  of  the 
attitude  of  the  general  public. 

The  stock  market  with  its  usual  sound  foresight  will  forecast 
accurately  the  ultimate  outcome  long  before,  and  not  after,  the 
event.  What  effect  will  this  have  upon  the  present  level  of  the 
various  railroad  securities? 

There  are  railroad  securities  which  possess  such  sound  invest- 
ment characteristics  as  these: 

1.  The  balance  sheet  of  each  company  shows  a  good  balance 

of  current  assets  over  current  liabilities. 

2.  The  property  of  each  company  is  in  a  high  state  of  physical 

development.  The  integrity  of  the  net  earnings  as 
reported  by  these  companies  taken  as  a  whole,  cannot 
be  questioned,  as  their  average  maintenance  charges 
have  been  very  large. 

3.  Each  company  operates  a  large  system  of  railroads,  and 

owns  terminals  of  great  value. 

4.  Each   company  earns  annually  a   large   margin   over  its 

fixed  charges,  and  has  the  direction  of  a  management 
both  honest  and  efficient. 

These  stocks  are  readily  marketable,  are  generally  considered 
by  the  banks  as  first-class  collateral,  and  they  are  certainly 
capable  of  considerable  appreciation  in  value.  They  are  offered 
to  investors  at  attractive  prices,  at  least  a  great  many  of  them. 

There  are  likewise  among  the  railroad  securities,  stocks  and 
bonds  which  no  supporting  hand  of  Government  can  be  expected 
to  maintain  upon  an  investment  level.  These  are  also  offered 
to  investors  daily. 

Which  is  Which? 


CHAPTER    II 

THE    USE   OF   STATISTICS 

The  Basis  of  Value 

The  investor  does  not  find  the  mere  name  of  a  security  — 
bond,  preferred  stock,  or  common  stock  —  at  all  the  proper 
answer  to  the  question  raised  in  the  preceding  chapter,  "Which 
is  Which?" 

The  name  "bond"  does  not  carry  with  it  any  guaranty  of 
quality.  So  far  as  the  term  is  accepted  as  a  synonym  of  pro- 
tection or  safety,  it  is,  in  this  day,  a  misnomer.  In  recent  years 
so  many  new  kinds  of  railroad  bonds  have  been  introduced  into 
our  market,  that  the  investor  must  use  great  care  lest,  in  pur- 
chasing a  bond,  he  finds  himself  possessed  of  a  security  far 
inferior  in  grade  to  many  railroad  stocks  in  which  he  would  not 
choose  to  invest. 

There  are  outstanding  today  various  kinds  of  collateral 
bonds;  bonds  the  joint  obligation  of  two  or  more  railroads; 
bonds  the  joint  obligation  of  railroad  and  coal  companies; 
participating  bonds;  convertible  bonds;  debenture  bonds  with 
no  security;  debenture  bonds  collaterally  secured;  debenture 
bonds  to  be  secured  by  mortgage  in  the  event  of  a  new  mortgage 
being  placed  upon  the  property  in  the  future.  The  names  of 
bonds  vary,  as  prior  lien,  general  lien,  divisional,  consolidated, 
unified,  first  consolidated,  first  mortgage,  second  mortgage, 
third  mortgage,  extension  mortgage,  plain  "bonds,"  etc. 
Needless  to  say,  a  third  mortgage  bond  of  one  company  may 
be  infinitely  more  secure  than  a  fiist  mortgage  or  prior  lien 
mortgage  bond  of  another  company.  "Bond"  is  a  generic 
term  as  "bird,"  "plant,"  "flower."  This  is  taken  up  in  detail 
in  the  Textbook,  "Investment  Securities." 

The  value  of  a  security  must  rest  today,  more  than  ever 
before,   upon   the  earning  capacity  and   the  character  of   the 


16  A    Railroad  Security 

management  of  the  issuing  company.  A  bond  may  be  a  first 
mortgage  on  property,  the  value  of  which  is  much  greater  than 
the  face  value  of  the  bonds  issued  against  it,  yet  this  bond  may 
suffer  considerably  in  the  market,  owing  to  the  fact  that  the 
issuing  company  has  outstanding  other  bonds  issued  against 
insufficient  security,  the  result  being  that,  if  such  company's 
credit  becomes  impaired,  all  the  bonds  of  the  company,  good 
and  bad  alike,  will  suffer  depreciation.  The  value  of  a  bond, 
while  based  upon  the  value  of  the  security  behind  it,  rests  on 
the  fact  that  this  value  depends  largely  upon  revenue-producing 
ability. 

Correct  Use  of  Statistics 

Since  earning  power  represents  the  real  source  of  a  security's 
value,  too  great  emphasis  cannot  be  laid  upon  the  importance 
to  the  investor  of  a  right  understanding  of  the  methods  by 
means  of  which,  through  the  analysis  of  railroad  reports,  he  can 
secure  sound  knowledge  of  this  earning  power. 

Economical  operation  of  every  railroad,  every  corporation, 
every  factor  and  shop,  and  every  wholesale  and  retail  store 
would  be  well  nigh  impossible  were  the  operating  official,  general 
manager,  or  head  of  department,  not  kept  fully  posted  by  sta- 
tistics relating,  as  the  case  may  be,  to  car  mileage,  ton  mileage, 
cost  of  production,  cost  of  distribution,  etc.  It  is  safe  to  say 
that,  in  our  industrial  life  today,  the  intelligent  use  of  statistics 
plays  a  more  important  part  than  ever  before  in  leading  to 
economies.  The  very  life  of  many  successful  business  enter- 
prises today  is  due  to  the  fact  that  their  managers  have  been 
alive  to  the  advantage  of  a  correct  use  of  statistics. 

It  is  safe  to  say  that  many  unsuccessful  investors  have  only 
themselves  to  blame,  in  large  measure,  for  the  losses  which  they 
suffer  year  in  and  year  out.  To  the  investor  the  free  and 
sensible  use  of  statistics  will  bring  more  satisfactory  results,  as 
such  use  produces  results  satisfactory  to  the  business  manager. 
Investors  are  constantly  deceived  by  time-worn  phrases  such  as 
"the  bonded  debt  is  only  $5,000  per  mile,"  "the  ratio  of  opera- 
ting expenses  is  only  58  per  cent,"  "the  stock  is  earning  thus 


The     Use   of  Statistics  17 

and  so."  The  investor  must  use  statistics  intelligently  to  learn 
what  they  disclose  as  well  as  what  they  conceal;  what  they  admit 
as  well  as  what  they  deny. 

Railroad  Reports 

All  too  few  details  are  given  in  many  railroad  reports  of 
today  as  to  the  physical  characteristics,  the  character  of  rail 
and  ballast,  the  number  of  grade  crossings,  the  extent  and 
nature  of  curvatures  and  gradients,  and  the  number  and  charac- 
ter of  bridges,  culverts,  etc.,  etc.  Knowledge  of  all  these,  as 
well  as  of  the  character  and  density  of  traffic  and  of  the  general 
conditions  attendant  upon  the  obtaining  and  conduct  of  such 
traffic,  is  essential  to  the  complete  understanding  of  the  merits 
of  railroad  securities;  yet  invaluable  information  hearing  upon 
their  relative  merits  can  he  acquired  hy  comparison  of  the  income 
accounts  of  the  different  roads.  While  the  peculiar  and  varying 
conditions  under  which  each  individual  road  must  be  operated 
impair  comparisons,  yet  analysis  points  to  certain  undisputed 
conclusions  and  gives  an  index  to  the  truth. 

There  are  many  railroads  of  which  it  must  be  said  that  their 
"cost  of  road,  structures,  and  equipment,"  as  exhibited  in  their 
financial  statements,  includes  very  large  items,  representing 
altogether  fictitious  values.  On  the  other  hand,  it  must  be 
stated  in  fairness  that,  owing  to  the  large  expenditures  for 
improvements,  additions,  equipment,  etc.,  which  for  a  series  of 
years  have  been  deducted  from  their  surplus  income,  the  "cost 
of  road,  structures,  and  equipment"  of  a  large  number  of  railroads 
is  today  understated  in  their  balance  sheets.  Where  fictitious 
values  are  given  it  will  be  found  that  these  result  from  the 
charges,  dating  perhaps  long  ago,  of  excessive  amounts  for 
"discount  on  bonds,"  "reorganization  expenses,"  and  through 
the  charging  for  construction  of  amounts  which  today  would  be 
considered  fabulous.  Per  contra,  taken -in  a  strict  sense,  "bonds 
and  stocks  outstanding"  represent  in  many  instances  little 
save  an  equity  in  earning  power.  So  it  becomes  of  prime 
importance  to  ascertain  the  "earning  power"  of  each  railroad  in 
order  that  through  the  comparison  of  the  "earning  power"  of 


18  A    Railroad   Security 

each  with  that  of  the  other,  certain  conclusions  as  to  the  respec- 
tive merits  of  their  bonds  and  stocks  may  be  deduced. 

Uniformity  of  Reports 

As  a  rule,  this  comparison  can  be  made  easily  and  intelli- 
gently owing  to  the  uniformity  in  this  regard  of  the  reports 
submitted  by  the  railroad  companies.  Recent  legislation  by 
Congress  has  resulted  in  establishing  in  the  reports  of  railroads 
a  practical  uniformity  which  has  never  before  existed.  While 
the  balance  sheets  of  many  railroads  are  not  as  complete  and 
satisfying  as  they  should  be,  yet  individual  investigation  into 
the  financial  condition  of  any  road  can  readily  be  made,  and,  as 
a  rule,  its  strength  or  weakness  financially  ascertained. 

Accounting  Regulations  of  Interstate  Commerce  Com- 
mission 

It  is  necessary  to  point  out  that  the  legislation  enacted  by  Congress  in  June,  1906,  has  given 
absolute  power  to  the  Interstate  Commerce  Commission  in  its  discretion  to  "prescribe  the 
forms  of  any  and  all  accounts,  records,  and  memoranda  to  be  kept  by  carriers  subject  to  the 
provision  of  this  Act,  including  the  accounts,  records,  and  memoranda  of  the  movement  of 
trafific  as  well  as  the  receipts  and  expenditures  of  money.  The  Commission  shall  at  all  times 
have  access  to  all  accounts,  records,  and  memoranda  kept  by  carriers  subject  to  this  Act,  and 
it  shall  be  unlawful  for  such  carriers  to  keep  any  other  accounts,  records  or  memoranda  than 
those  pi  escribed  or  approved  by  the  Commission. 

The  provisions  of  this  Act  in  so  far  as  they  relate  to  accounting  for  receipts  and  disburse- 
ments went  into  effect  July  1st,  1907.  The  reports  issued  by  the  railroads  concerning  opera- 
tions prior  to  July  1st,  1907,  were  made  up  on  the  old  basis,  and  the  statements  and  statistics 
given  in  this  book  so  fai  as  they  relate  to  operations  prior  to  July  1st,  1907,  are  made  up  on 
the  old  basis. 

On  July  1,  1914.  a  complete  revision  of  the  accounting  system  of  railroads  was  ordered 
by  the  Commission.  The  readjustment  of  the  various  accounts  makes  comparison  witli  former 
years  extremely  difficult. 

The  changes  in  accounting  when  their  operations  are  perfected  will  cause  seveial  changes 
to  be  made  in  the  suggestions  and  remarks  embodied  in  the  various  Chapters;  yet,  as  a  whole, 
the  integrity  of  the  discussion  on  the  analysis  of  railroad  reports  will  remain  virtually  without 
change. 

Briefly,  the  instructions  issued  by  the  Commission  under  the  provisions  of  the  Act  above 
referred  to,  stipulate  that,  beginning  July  1st,  1907,  charges  foi  construction,  additions,  better- 
ments, equipment  and  all  such  charges  of  an  extraordinary  nature  and  not  strictly  operating 
expenses  shall  not  be  charged  to  Maintenance  Expenses  or  otherwise  included  in  Operating 
Expenses  so  as  to  constitute  a  deduction  from  Net  Earnings.  Expenditures  of  this  nature 
may  at  the  discretion  of  the  railroad  be  either  capitalized  or  deducted  from  the  year's  surplus 
as  ascertained  after  all  fixed  charges  and  dividends  have  been  deducted.  For  example,  begin- 
ning July  1st,  1907,  no  charges  are  allowed  to  be  made  to  Maintenance  of  Way  for  improve- 
ments or  betterments  to  track  or  structures  where  such  improvements  or  betterments  exceed 
in  each  case  $200;    also  in  the  case  of  Maintenance  of  Equipment,  the  cost  of  new  equipment 


The     Use   of  Statistics  19 

except  where  purchased  for  replacement,  is  not  allowed  to  be  charged  (as  in  the  past  it  has 
frequently  been  charged)  to  that  account.  It  was  the  purpose  of  the  Commission  to  establish 
definite  rules  and  regulations  which  should  govern  "Renewals"  and  the  "Depreciation"  ac- 
counts, the  purpose  of  these  accounts  being  that  "all  the  cost  of  maintenance  and  not  more 
than  the  cost  of  maintenance  shall  be  charged  to  the  maintenance  accounts  of  Operating  Ex- 
penses." The  importance  to  the  investor  of  the  new  accounting  rules  established  by  the 
Interstate  Commerce  Commission  cannot  be  overestimated.  To  quote  from  a  communication 
by  the  Interstate  Commerce  Commission,  "there  will  arise  a  general  confidence  in  railway  se- 
curities which  will  give  them  a  sure  and  stable  value,  provided  the  enterprise  which  they 
represent  is  a  sound  commercial  enterprise." 

The  new  system  when  fully  established  not  only  will  result  in  close  uniformity  in  the 
reports  of  all  the  railroads,  but  also  will  tend  to  prevent  deception  in  either  undercharging  or 
overcharging  Maintenance  Expenses  on  account  of  repairs  and  renewals. 

For  the  fiscal  years  ending  June  30,  1908,  to  June  30,  1916,  the  accountants  of  the  different 
railroads  were  privileged  to  base  their  charges  on  account  of  depreciation  of  equipment  upon 
what  they  deemed  a  fair  basis,  stating  in  their  reports  to  the  Interstate  Commerce  Com- 
mission the  exact  basis  upon  which  this  depreciation  was  computed.  Thereafter,  as  will  be 
discussed  in  the  Chapter  "Maintenance  of  Equipment,"  each  railroad  in  its  report  to  the 
Commission  was  called  upon  to  justify  its  charges  on  account  of  depreciation  of  equipment. 
It  is  understood  that  the  Interstate  Commerce  Commission  will  in  due  course  issue  definite 
instructions  in  legard  to  this  depreciation  charge  on  equipment  which  will  thereafter  apply 
to  all  the  railroads.  To  the  extent  that  today  the  depreciation  charge  varies  on  the  different 
railroads,  the  present  accounting  scheme  lacks  uniformity. 

The  Commission  on  July  1,  1914,  issued  a  re-classification  of  Operating  Expenses,  which 
will  be  referred  to  hereafter.  This  new  classification  of  expenses  provides  for  the  creation  of 
depreciation  reserves  for  railroad  property  other  than  equipment  by  means  of  charges  to  operat- 
ing expenses.  The  use  of  these  depreciation  accounts  is  for  the  present  optional  and  it 
will  likely  be  some  years  before  a  basis  of  comparison  may  be  determined. 

In  the  statements  of  Income  Account  in  this  book  taxes  are  included  in  Fixed  Charges  as 
explained  in  Chapter  XI.  Reference  is  here  made  to  this  fact  for  the  reason  that  according 
to  the  rules  of  the  Interstate  Commerce  Commission,  since  July  1,  1907,  taxes  have  been  de- 
ducted from  Net  Operating  Revenues  and  are  not  considered  as  a  part  of  the  Fixed  Charges. 


CHAPTER    III 
INCOME   ACCOUNT* 


Items  Included 


The  income  account,  or  statement  of  the  earnings  and  expenses 
for  the  fiscal  period,  is  now  given  in  railroad  reports  as  follows: 

Operating  Revenues    $10,000,000 

Operating  Expenses  6,000,000 

Net  Operating  Revenues    $4,000,000 

Taxes   375,000 

Operating  Income    $3,625,000  . 

Other  Income   200,000 

Total  Income  or  Gross  Corporate  Income $3,825,000 


Deductions  from  Income  or  Fixed  Charges: 

Interest    $1,500,000 

Rentals    75,000 

Sinking  Funds,  etc 25,000 

Hire  of  Equipment     25,000 

Total  Fixed  Charges $1,625,000 

Net  Income $2,200,000 

Dividends    1 ,000,000 

Additions  and  Betterments    700,000 

Surplus     500,000 

Classification  and  Terms  Used 

For  the  sake  of  uniformity  the  general  accounts  as  given  in 
the  statements  of  Income  Accounts  in  this  book  are  arranged  in 
order  and  styled  as  explained  on  following  page. 

♦Note:  "Accounting  Regulations  of  Interstate  Commerce  Commission,"  p.  17. 


Income   Account 


21 


Accounts  Prescribed  by  Inter- 
state Commerce  Commission 

Operating  Revenues 
Operating  Expenses 
Net  Operating  Revenues 
Taxes 

Operating  Income 

Non-Operating  Income 

Gross  Corporate  Income 

Deductions  from  Gross  Income  or 
Fixed  Charges 

(Under  this  heading  are  included 
"Hire  of  Freight  Cars"  ■ —  Dr., 
and  "Rent  of  Equipment") 

Net  Income 


Terms  Used  in  This  Text 

Operating  Revenues 

Operating  Expenses 

Net  Operating  Revenues 

Taxes  are  included  in  Fixed  Charges 

and  the  amount  thereof  specified 
Not  used  (see  under  Taxes) 
Other  Income 
Gross  Income 
Fixed  Charges 

{Under  this  heading  are  included 
"Hire  of  Freight  Cars" — Dr.,  and 
"  Rent  of  Equipment"  and  "Taxes" 
the  amounts  being  specified) 

Net  Income 


To  any  one  at  all  familiar  with  railroad  reports  each  of  the 
above  items  is  self-explanatory.  Only  a  brief  survey  is  necessary.. 
In  ascertaining  the  earning  power  or  the  ability  of  a  road  tO' 
pay  interest  and  dividends,  the  most  important  item  of  the 
Income  Account  to  be  considered  is  the  Operating  Expenses. 


What  Income  Account  Covers 

Operating  revenues  are  revenues  received  from  the  direct 
operation  of  the  railroad.  Returns  on  stocks  held  in  the 
treasury  of  the  company  are  not  included  as  operating  revenues. 
Rentals  received  from  loaning  equipment  to  other  roads  are  not 
so  included.  It  is  simply  the  gross  revenues  received  from  the 
transportation  of  goods  and  passengers. 

Operating  expenses,  which  will  be  discussed  in  detail  in  the 
next  chapter,  cover  all  the  expenses  necessary  to  carry  on  the 
operations  above  described.  This  it  will  be  seen  means  not  only 
running  trains  but  running  the  organization  as  well  and  the 
maintaining  of  both  the  organization,  the  equipment,  and  the 
roadbed  of  the  company. 

The  balance  between  these  two  items  is  known  as  New 
Operating  Revenue.     In  other  words,  it  is  the  balance  left  from 


22  A    RailroadSecurity 

the  carrying  of  commodities  of  all  types  after  necessary  expenses 
to  obtain  them  and  carry  them  have  been  deducted. 

Other  Income,  or  Non-Operating  Income,  is  income  received 
from  all  outside  sources  —  dividends  and  interest  on  securities 
held,  revenue  from  the  operation  of  dining  cars  and  rentals 
received  from  the  hire  of  the  road's  equipment  by  other  prop- 
erties. 

Gross  income  is  simply  the  gross  result,  after  the  addition 
of  outside  income  to  the  revenue  received  from  the  direct  opera- 
tion of  the  railroad  property. 

Fixed  Charges  include  first,  taxes  that  the  company  is 
forced  to  pay  both  the  State  and  the  Federal  Government; 
second,  any  money  expended  for  hire  of  equipment  from  other 
properties.  This  hiring  and  loaning  of  equipment  will  be 
discussed  in  detail  in  later  chapters.  Third,  and  in  many  cases 
the  most  important  item,  is  Fixed  Charges  —  the  interest  obliga- 
tions of  the  company.  As  has  been  shown  previously  railroad 
development  in  this  country  has  brought  about  a  much  more 
rapid  increase  in  bonded  indebtedness  than  in  stock  capitaliza- 
tion. For  that  reason  this  item  of  fixed  charges  has  to  be  scru- 
tinized with  greater  care  now  than  at  any  other  time. 

Net  Income  is  the  balance  left  after  all  these  operations  and 
all  charges  against  the  revenues  of  the  company  from  whatever 
sources  received.  That  is,  it  is  the  net  balance  a\'ailable  for 
distribution  to  the  partners  in  the  enterprise  —  the  stockholders. 


CHAPTER    IV 

OPERATING    EXPENSES* 

Seven  General  Accounts 

The  operating  expenses  of  almost  all  the  railroads  in  the 
United  States  are  classified  according  to  rules  prescribed  by  the 
Interstate  Commerce  Commission.  The  primary  accounts  are 
all  embodied  under  seven  general  accounts,  as  follows: 

1.  Maintenance  of  Way  and  Structures.! 

2.  Maintenance  of  Equipment. 

3.  Traffic  Expenses. 

4.  Transportation  Expenses. 

5.  Miscellaneous  Operations. 

6.  General  Expenses. 

7.  Transportation  for  Investment  —  Cr. 

Explanation  of  Accounts 

1.  Under  Maintenance  of  Way  and  Structures  fall  expenses 

for  the  repairs  and  renewals  of  machinery  and  tools,  for 
repairs  of  roadway,  track,  tunnels  and  subways,  for 
ballasting,  for  repairs  and  renewals  of  switches,  frogs, 
ties,  fences,  bridges,  culverts,  stations,  shops,  buildings, 
etc.,  likewise  according  to  a  ruling  of  the  Interstate 
Commerce  Commission  depreciation  of  track,  roadway, 
etc.  (optional). 

2.  Under  Maintenance  of  Equipment  fall  expenses  for  the 

repairs  and  renewals,  as  well  as  depreciation  of  loco- 
motives, passenger  cars,  freight  and  other  cars  and  of 
steamboats  and  for  the  maintenance  of  shop  machinery, 
etc. 


*Note:  "Accounting  Regulations  of  Interstate  Commerce  Commission,"  p.  17. 

^Styled  Maintenance  of  Way  in  this  book. 


24  A    Railr  0  a  d   S  ectirit  y 

3.  Under  Traffic  Expenses  fall  wages  of  officers  directly  in 

charge  of  traffic,  freight,  passenger,  baggage  and  other 
agents,  expenses  of  outside  agencies,  advertising,  fast 
freight  lines,  industrial  and  immigration  bureaus,  etc. 

4.  Under   Transportation    Expenses*    fall   wages   of   station 

employes,  clerks,  yardmen,  flagmen,  watchmen,  engine- 
men  and  trainmen,  cost  of  dispatching  trains,  expenses 
for  telegraph  and  station  service,  cost  of  fuel  and 
supplies  for  locomotives,  expenses  for  water  supply, 
loss  and  damage,  operating  joint  yards  and  terminals 
(net),  etc. 

5.  Under  Miscellaneous  Operations  fall  expenses  of  dining 

and  buffet  service,  hotels  and  restaurants,  grain  eleva- 
tors, stockyards,  producing  power  sold,  etc. 

6.  Under  General   Expenses  fall  salaries  of  general  officers 

and  office  clerks,  expenses  for  legal  service,  insurance, 
etc. 

7.  By   means  of   this   account   "Transportation   for   Invest- 

ment—  Cr."  operating  expenses  are  credited  with  the 
cost  of  transportation  on  revenue  trains  of  men  engaged 
in  and  material  for  construction,  which  expense  is 
concurrently  charged  to  various  property  accounts. 

How  Accounts  are  Grouped 

It  appears  at  once  from  the  nature  of  the  expenses  which  fall 
under  these  headings  that  the  amount  of  the  expenditures  under 
one  (1)  and  two  (2)  is,  to  a  considerable  degree,  subject  to  the 
control  of,  and  other  things  being  equal,  reflects  the  conserva- 
tism or  lack  of  conservatism  in  the  road's  management.  On  the 
■other  hand,  under  three  (3),  four  (4),  five  (5),  and  six  (6),  fall 
expenditures  which  are  wholly  obligatory  in  that  while  they 
fluctuate  each  year  with  the  volume  of  business,  train  mileage, 
etc.,  they  are  outlays  which  are  for  the  most  part  incident  to 
the  present  conduct  of  the  road's  traffic. 


♦Note:  Where  railways  operate  water  lines  their  expenses  include  the  account  "Trans- 
portation-Water Lines"  (in  this  text  included  in  "Transportation  Expenses.") 


operating  Expenses  25 

These  subdivisions  of  the  operating  expenses  may  then  be 
divided  into  two  classes: 

A.  Maintenance  Expenses. 

B.  Traffic,  Transportation,  Miscellaneous  Operations,  Gen- 
eral Expenses,  and  Transportation  for  Investment  —  Cr. 

The  classification  of  Operating  Expenses,  as  above,  is  in 
accordance  with  a  ruling  of  the  Interstate  Commerce  Commission 
issued  July  1,  1914.  For  the  seven  years  prior  to  July  1,  1914, 
Operating  Expenses  were  sub-divided  into  five  accounts,  viz: 
(1)  Maintenance  of  Way  and  Structures;  (2)  Maintenance  of 
Equipment;  (3)  Trafific  Expenses;  (4)  Transportation  Expenses; 
(5)  General  Expenses.  For  a  number  of  years  prior  to  July  1, 
1907,  there  were  but  four  subdivisions  of  Operating  Expenses  in 
general  use;  viz:  —  one  and  two,  as  above.  Conducting  Trans- 
portation and  General  Expenses. 


CHAPTER   V 
MAINTENANCE   EXPENSES* 

Significance  to  Investors 

There  are  many  railroads  in  the  United  States  whose  mainte- 
nance outlays  have  been,  and  are,  clearly  inadequate.  Many 
more  railroads  are  found,  however,  whose  maintenance  outlays 
have  been  heavily  surcharged  each  year.  Too  often  investors 
are  deceived  by  the  general  statement  in  the  annual  report 
that  "the  management  is  gratified  to  be  able  to  say  to  the 
shareholders  that  the  close  of  the  fiscal  year  finds  the  property 
of  the  company  in  as  good  condition  as  it  was  last  year."  This 
is  not  sufficient. 

Keen  competition  and  the  teaching  of  the  numerous  reor- 
ganizations have  forced  upon  the  managers  the  necessity  of 
charging  to  income  items  which  were  formerly  charged,  and 
from  an  accounting  standpoint,  often  might  properly  be  charged 
to  capital  account.  So  the  management  should  be  able  to  say, 
in  lieu  of  the  above,  that  the  improvement  work  has  so  progressed 
during  the  fiscal  period  as  to  keep  the  property  substantially 
abreast  of  its  competitors.  There  are  few  railroads  in  the 
United  States  whose  financial  policy  has  been  of  a  constructive 
order,  which  cannot,  with  earnings  as  they  have  averaged  in 
the  past  several  years,  fully  maintain  their  property  and  pay 
their  fixed  charges.  There  are  many,  which  as  the  event  has 
proved,  could  not  do  this  and,  in  addition,  pay  dividends. 

What  Analysis  Will  Show 

Analysis  of  the  yearly  expenses  for  Maintenance  of  Way  and 
for  Maintenance  of  Equipment  will  show  distinctly  whether  or 
not  a  road  is  becoming  more  liberal  in  that  regard. 

*Note:  "Accounting  Regulations  of  Interstate  Commerce  Commission,"  p.  17. 


Mainte  71  ance  Expenses  27 

Comparison  of  the  maintenance  expenses  of  different  roads 
operating  under  like  conditions  will  tend  to  establish  the  relative 
policy  pursued  by  each. 

As  will  be  shown  in  subsequent  chapters,  a  consideration  of 
maintenance  expense  is  vital  to  ev^ery  inv^estor  who  desires  to 
carefully  analyze  individual  railroad  companies.  He  must  be 
careful,  as  shown  above,  not  to  compare  the  maintenance  expen- 
ditures of  a  Southwestern  Railroad  with  those  of  Eastern  Trunk 
Lines.  He  can  follow,  and  follow  carefully,  the  growth  or  lack 
of  growth  in  maintenance  expenditures  of  any  one  property  over 
a  period  of  years. 

It  will  be  immediately  appreciated  that  maintenance  is  an 
item  which  may  be  used  either  to  make  a  showing  unduly 
favorable  or  to  cover  up  a  considerable  earning  power.  Sub- 
sequent chapters  will  give,  roughly,  satisfactory  average  main- 
tenance charges  over  a  series  of  years.  This  will  assist  the 
investor  in  ferreting  out  when  over-maintenance  or  under- 
maintenance  exist,  if  either. 

Just  as  industrials  during  the  war  period  were  able  to  write 
down  their  plant  accounts  to  a  very  low  basis  and  as  a  result 
show  only  moderate  net  returns  for  stockholders  so  it  is  possible 
for  a  railroad  to  do  so  —  to  a  lesser  degree,  on  account  of  specified 
accounting,  to  be  sure  — •  but  still  to  a  degree  that  merits  study. 
Maintenance  expenditures  in  the  years  following  the  return  of 
the  roads  to  private  operation  have  come  in  for  considerable 
discussion.  For  that  reason  careful  study  of  this  item  is  sug- 
gested. Such  study  will  undoubtedly  show  that  in  the  post- 
war readjustment  period  under-maintenance  of  our  railroads  was 
by  no  means  as  prevalent  as  many  financial  journals  have  led 
us  to  believe. 


CHAPTER   VI 
MAINTENANCE   OF   WAY* 

Using  the  "Per  Mile"  Basis 

Taking  two  roads  in  good  condition,  traversing  the  same  terri- 
tory and  meeting  linth  like  conditions  of  traffic,  etc.,  a  cursory 
study  as  to  their  maintenance  will  establish  which  of  the  two  is 
following  the  more  conservative  policy.  The  best  standard  to 
be  followed  by  the  average  student  of  railroad  reports  is  to 
reduce  the  Maintenance  of  Way  Expenses  to  a  "per  mile" 
basis.  Take  the  total  expenses  under  this  head  and  divide  them 
by  the  average  number  of  miles  operated  for  the  period  under 
review.  A  certain  amount  must  be  appropriated  each  year  for 
the  maintenance  of  the  roadway  and  structures,  whether  the 
business  of  the  road  be  large  or  small.  While  these  expenses 
must  of  necessity  vary  somewhat  with  the  density  of  traffic,  yet 
it  by  no  means  follows  that  a  road  with  a  density  of  1,000,000 
ton  miles  per  mile  of  road  should  spend  for  Maintenance  of 
W^ay  ten  times  as  much  as  another  road  which  has  a  density  of 
but  100,000  ton  miles  per  mile  of  road.  So  it  cannot  be  said 
that  a  road,  the  Operating  Revenues  of  which  are  $10,000  per 
mile,  should  spend  ten  times  as  much  for  Maintenance  of  Way 
as  the  road  which  earns  but  $1,000  per  mile.  It  follows  that 
one  road  may  appropriate  25  per  cent  of  its  gross  for  a  given 
period  for  Maintenance  of  Way  and  yet  not  spend  so  much 
relatively  as  the  road  which  so  appropriates  but  10  per  cent  of 
its  gross. 

Comparisons  and  Qualifications 

Neither  the  density  of  the  traffic  nor  the  extent  of  Operating 
Revenues  determines  the  fair  requirement  for  Maintenance  of 
Way.     Conditions  peculiar  to  each  road  will  mar  the  comparison 

*Xote:  "Accounting  Regulations  of  Interstate  Commerce  Commission,"  p.  17. 


AI  a  i  n  t  e  }i  a  n  c  e   of   Way  29 

between  the  amounts  per  mile  expended  by  different  roads.  One 
road  has  a  regular  profile,  as  the  Northern  Pacific;  another 
traverses  a  mountainous  country,  as  the  Atchison;  another 
obtains  its  ballast  from  its  own  gravel  pits,  conveniently  located; 
another  its  ties  with  advantage;  yet  another  has  many  and 
expensive  bridges  and  tunnels  to  maintain,  etc.,  etc.  One  road 
may  expend  but  $800  per  mile  for  Maintenance  of  Way  and  yet 
better  maintain  the  standard  of  its  property  than  another  road 
which  expends  an  average  of  $1,000  per  mile.  Some  roads 
have  branch  lines  where  it  would  be  wasteful  under  existing  con- 
ditions of  traffic  to  expend  more  than  $500  or  so  per  mile.  The 
small  expenditures  on  these  branch  lines  would  reduce  con- 
siderably the  average  outlay  for  the  system,  yet  it  would  not 
follow  that  this  relatively  small  average  outlay  was  working  to 
the  disadvantage  of  this  system  with  reference  to  competitive 
business. 

Obviously  the  road  with  a  considerable  mileage  of  second  and 
third  tracks  should  require  a  larger  expenditure  "per  mile  of  road" 
for  Maintenance  of  Way  than  the  road  with  few  or  no  additional 
main  tracks.  Where  the  roads  to  be  compared  have  double 
tracks,  comparison  should  be  made  of  the  Maintenance  of  Way 
"per  mile  of  single  main  track,"  although  it  should  be  borne  in 
mind  that  it  costs  more,  under  like  conditions  to  maintain  two 
miles  of  single  track  than  one  mile  of  double  track.  Another 
modification  arises  from  the  fact  that  the  nature  and  extent  of 
the  business  of  certain  roads  necessitate  the  maintenance  of  a 
relatively  large  percentage  of  side  and  passing  tracks. 

Reasons  for  Increase 

During  recent  years  Maintenance  of  Way  Expenses  have 
shown  a  natural  tendency  to  increase.  Railroads  which  in  the 
past  have  used  75  to  80  pound  rail  in  main  track  have  made 
their  renewals  largely  with  the  more  costly  90  and  100  pound 
rail;  likewise  50  to  60  pound  rail  has  been  replaced  with  70  to 
80  pound  rail.  The  heavier  rail  has  been  found  necessary 
owing  to  the  increasing  use  of  steel  equipment  and  larger  loco- 
motives.    The  use  of  this  heavy  equipment  has  compelled  the 


30  A    Rail  r  o  a  d   S  ecurit  y 

railroads  to  replace  and  strengthen  bridges,  culverts,  and  em- 
bankments, and  to  spend  large  sums  for  ballasting,  etc.  Likewise 
ties,  rail  joints,  and  other  materials,  have  considerably  advanced 
in  cost. 

It  is,  therefore,  safe  to  say  that  when  a  railroad's  Maintenance 
of  Way  Expenses  average  below  $900  to  $1,200  per  mile  of  road 
these  expenses  should  receive  careful  scrutiny  by  the  intending 
investor.     It  is  a  sign  of  possible  danger! 

Ruling  of  the  Commission 

As  stated  in  a  previous  chapter  Maintenance  of  Way  Expenses 
now  include  accounts  for  Depreciation.  The  ruling  of  the 
Commission  dated  July  1,  1914,  follows: 

"Depreciation  of  Fixed  Improvements.  —  Depreciation 
accounts,  in  which  to  include  uniform  monthly  charges  to  cover 
the  depreciation  of  fixed  improvements,  have  been  provided  for 
the  purpose  of  creating  reserves  which  will  meet  or  reduce  the 
amounts  otherwise  chargeable,  as  may  be  appropriate,  to  operat- 
ing expense  or  to  profit  and  loss  accounts  to  cover  property  re- 
tired. Such  depreciation  charges  shall  be  based  in  each  instance 
upon  the  precentage  of  the  original  cost  (estimated  if  not  known), 
ledger  value,  or  purchase  price  of  the  property  determined  to 
be  equitable  by  the  carrier's  experience  and  best  sources  of 
information  as  to  the  actual  current  loss  from  depreciation.  A 
statement  of  the  bases  used  by  the  carriers  for  computing  these 
charges  shall  be  included  in  its  annual  report  to  the  Commission. 
Until  further  directed  the  use  of  depreciation  accounts  for  fixed 
improvements  is  optional  with  the  carrier." 

This  makes  "Maintenance"  a  much  truer  picture  and  in- 
creases its  importance  in  an  analysis  of  a  railroad  security. 


CHAPTER   VII 
MAINTENANCE   OF   EQUIPMENT* 

Tests  to  Apply 

Comparison  of  the  Maintenance  of  Equipment  Expenses 
"per  mile  of  road"  avails  little.  The  best  basis  for  testing  the 
sufficiency  of  these  is  to  ascertain  the  average  amount  expended 
on  equipment  per  unit  of  service  rendered  by  the  equipment; 
that  is,  the  average  outlay  per  locomotive  per  mile  run,  per 
freight  car  per  mile  run,  and  per  passenger  car  per  mile  run. 
Maintenance  of  Equipment  depends  not  alone  upon  the  amount 
of  equipment  to  be  maintained,  but  also  upon  the  service 
rendered  by  the  equipment. 

It  stands  to  reason  that  the  Erie  Railroad,  with  a  freight 
density,  as  of  1917,  of  4,643,434  ton  miles  and  a  passenger 
density  of  286,998  passenger  miles  per  mile  of  road,  must  expend 
more  "per  mile  of  road"  for  Maintenance  of  Equipment  than  the 
Atchison,  with  a  freight  density,  as  of  last  year,  of  1,143,743  ton 
miles,  and  a  passenger  density  of  137,648  passenger  miles  per 
mile  of  road.  The  relatively  larger  volume  of  business  done  or 
work  performed  by  the  Erie  requires  a  relatively  larger  amount 
of  Equipment  and  a  greater  service  to  be  rendered  by  its  equip- 
ment. Thus,  it  will  be  found  that  Maintenance  of  Equipment 
Expenses  have  usually  a  direct  relation  to  the  road's  freight  and 
passenger  density,  this  relation  being  affected  to  a  considerable 
degree  by  train  and  car  loading  and  other  essential  factors. 

An  example  will  tend  to  establish  that  equipment  maintenance 
has  necessarily  no  relation  to  gross  earnings.  Suppose  the 
tonnage  of  one  road  consists  altogether  of  low-class  freight,  as 
coal  or  iron  ore,  and  the  tonnage  of  another  road  wholly  of  high 
class  freight.     Each  road  earns  $20,000  per  mile.     The  density 


*Note'  "Accounting  Regulations  of  Interstate  Commerce  Commission,"  p  .17. 


32  A    Railroad   Security 

of  the  first  road's  traffic  and,  as  a  consequence,  the  service 
rendered  by  its  equipment,  must  be  far  greater  than  that  of  the 
second  road.  The  business  of  the  one  road  might  be  successfully 
conducted  with  one-third  of  the  equipment  and  power  required 
by  the  other:  Ergo,  an  outlay  of  $2,000  per  mile  for  equipment 
maintenance  on  the  road  with  low-class  tonnage  might  be  no 
greater,  relatively,  than  an  outlay  of  $1,000  per  mile  on  the  other 
road. 

Normal  Maintenance  Requirements 

It  may  be  said  that  under  conditions  prioi'  to  the  war,  an 
average  of  $2,500  to  $3,000  per  annum  per  locomotive,  $75  to 
$85  per  annum  per  freight  car  and  $750  to  $850  per  annum  per 
passenger  car  approximated  normal  maintenance  requirements. 
All  this  depends  much  upon  the  character  of  equipment  required 
in  the  service.  It  usually  costs  less,  for  example,  to  purchase 
and  maintain  coal  cars  and  fiat  cars  than  box  cars  and  refrigera- 
tor cars.  No  argument  is  necessary  to  show  that  it  must  cost 
more  per  unit  to  maintain  a  small  equipment  than  a  larger  one. 

Among  other  important  considerations  which  bear  upon  the 
cost  of  maintaining  a  road's  locomotives  and  cars  may  be 
mentioned  the  location  and  equipment  of  its  shops. 

There  are  many  roads  where,  although  maintenance  both 
for  roadway  and  equipment  was  clearly  surcharged,  the  extent 
of  the  excess  of  maintenance  over  normal  requirements  could 
not  be  taken  as  earning  power.  Take,  say,  during  their  rehabili- 
tation period  two  railroads  in  a  run-down  condition  as  distinct 
from  the  Lehigh  \'alley.  While  the  Lehigh  Valley  lias  not 
usually  reported  a  surplus  much  in  excess  of  dividend  require- 
ments, yet  it  should  be  able  to  pay  steadily  reasonable  dividends, 
for  the  reason  that  when  there  comes  a  bad  year,  there  is,  and 
for  years  has  been,  abundant  opportunity  for  curtailment  of 
maintenance  expenses.  After  reorganization,  in  the  case  of  the 
run-down  prfjperties,  the  needs  were  so  unusual  as  to  make 
imjjerative  extraordinary  charges  to  operating  expenses  for 
maintenance.  The  excess  of  these  expenses  over  normal  re- 
quirements could   be  considered  only  as  offering  a  promise  of 


Maintenance   of  Equipment  3S 

future  dividend-earning  capacity.     It  could  in  no  way  be  taken- 
as  an  immediate  margin  of  safety. 


Equipment  Depreciation  Ruling 

Following  the  rulings  of  the  Interstate  Commerce  Commission, 
a  majority  of  the  railroad  companies  charged  to  Maintenance  of 
Equipment,  amounts  for  depreciation  varying  from  six  per  cent 
to  one  per  cent  and  less. 

From  even  a  casual  examination  of  the  railroad  reports  for  the 
past  fiscal  year,  it  is  apparent  that  until  the  Commission  shall 
specify  the  exact  rate  to  he  charged  on  account  of  depreciation  of 
equipment,  the  desired  result  for  zvhich  the  law  was  enacted  ivilt 
not  be  attained. 

Hereafter  each  railway  in  its  report  to  the  Commission  must 
explain  the  basis  used  in  charging  depreciation  as  per  the  follow- 
ing rule  of  the  Commission. 

"The  various  depreciation  accounts  shall  include  uniform 
monthly  charges  representing  the  depreciation  of  equipment. 
These  charges  shall  be  based  upon  the  percentage  of  the  original 
cost  (estimated,  if  not  known),  ledger  value,  or  purchase  price  of 
such  equipment  determined  to  be  equitable  from  the  carrier's 
experience  and  best  sources  of  information  as  to  the  average 
current  loss  from  depreciation.  A  statement  of  the  percentages 
used  by  the  carrier  for  computing  these  charges,  together  with 
the  estimated  life  of  the  equipment  upon  which  such  percentages 
are  based,  shall  be  included  in  its  annual  report  to  the  Com- 
mission. 

"Depreciation  charges  with  respect  to  any  equipment  shall 
cease  ^hen  the  difference  between  the  ledger  value  and  the 
estimated  scrap  value  shall  have  been  credited  to  the  accrued 
depreciation  account." 

Depreciation  Rates 

The  following  table  indicates  the  rates  which  were  at  sl 
recent  time  under  more  or  less  normal  conditions  reported  ia 


^4 


A    Railroad   Security 


use  by  a  number  of  important  rai 
tion  of  equipment: — 

Locomo- 
tives 

% 

Atlantic  Coast  Line  R.R 3 

Baltimore  &  Ohio  R.R 4 

Boston  &  Maine  R.R 3 

C.  R.  R.  of  X.  J 4 

Chesapeake  &  Ohio  Ry 1}4 

Chi.,  M.  &  St.  Paul  Ry 1 

C,  C.  C.  &  St.  L.  Ry 2 

Dela.,  Lack'a  &  W.  R.  R 5t 

Erie  R.  R 3 

Great  Northern  Ry 5  J 

Illinois  Central  R.  R 3 

Lehigh  Valley  R.  R 2% 

Maine  Central  R.  R 3 

N.  Y.  Central  &  H.  R.  R.  R.  .  .  2 

Norfolk  &  Western  Ry 3 

Seaboard  Air  Line  Ry 2 

Southern  Rv 2 


Kvays  in  computing  deprecia- 


Passenger 
Train 
Cars 

Freight 
Train 
Cars 

Work 
Equip- 
ment 

% 

% 

% 

2* 

3 

2 

3 

3  to  5 

6 

2 

2 

2 

3 

4 

4 

IH 

1)^ 

IH 

1 

1 

1 

2 

2 

2 

■2Kt 

6t 

6t 

3 

4 

4 

4 

t 

t 

3 

4 

5 

m 

13ito2^ 

— 

2 

2 

2 

2 

2 

2 

3 

3 

3 

2 

2 

2 

2 

2J^  to  M 

2^ 

Charging  and  Crediting  Depreciation  Reserve 

As  an  example  of  the  method  used  by  the  railroads  in 
■charging  and  crediting  Depreciation  Reserve  the  following 
table  is  of  interest: — 

Reserve  for  Depreciation  of  Equipment 
Pennsylvania  R.  R.  1915 

•Credit  Balance  January  1,  1915    $17,461,707 

Credits  during  year  1915  — 

From  Charges  to  Operating  E.xpenses 

Depreciation  $6,177,124 

Renewals 383,636 

From  Salvage,  etc 1,186,526 

Amounts  charged  to  other  companies  for 
depreciation  on  P.  R.  R.'s  equipment 
used  by  them 1,705,473         9,452,760 

Total  Credits    $26,914,467 

♦Dining  cars  5%.  fLess  estimated  salvage  value. 

♦On  steam  locomotives  rates  vary  fiom  3.33%  to  7.14%  and  on  electric  locomotives  rate 
»3  10%;  on  freight  and  work  cars  rates  vary  from  3.33%  to  6.67%  (box  cars  4%  stock,  coal 
gondolas,  oil  tank,  etc.,  5%). 


Maintenanxe   of  Eqiiiptneiit  3S 

Less  — 

Equipment  Retired: 

Locomotives  $2,364,766 

Passenger  Cars 1,517,653 

Freight  Cars 2,775,645 

Work  Equipment 110,743 

Floating  Equipment    108,756       86,877,565; 

Credit  Balance  December  31,  1915 §20,036,904 

To  maintain  the  standard  and  value  of  the  equipment 
there  has  been  expended  out  of  the  above  for  new 
equipment   813,978,155 

And   for   the   balance   unexpended,    new   equipment    has   been 

ordered  under  contract    $6,058,749 

Various  Roads'  Expenditures 

The  following  table  for  1914-15  indicates  the  approximate- 
amounts  expended  under  more  or  less  normal  conditions  by 
various  railroads  for  repairs  and  renewals,  also  the  amounts 
charged  for  depreciation  of  equipment.  The  methods  of  calcu- 
lation used  by  the  companies  enumerated  below,  differ  radically. 
Practically  no  two  roads  mentioned  below  follow  the  same  rule- 
in  computing  depreciation  of  equipment  and,  likewise,  the  per 
unit  of  equipment  expenses  of  certain  roads,  for  example,  the- 
Atchison,  Topeka  &  Sante  Fe  Ry.  includes  certain  amounts 
charged  to  superintendence,  injuries  to  persons,  shop  machinery, 
maintaining  joint  equipment  at  terminals,  etc.  The  table: 
follows: 

Per  Per  Per 

Locomo-  Passenger         Freight 

tives  Car  Car 

Atch.,  Topeka  &  Santa  Fe  Ry 84,600  $1,204  $129 

El  Paso  Southwestern  Ry 2,927  1,083  105 

St.  Louis  Southwestern  Ry *2,295  *642  101 

Union  Pacific  R.  R 3,591  1,021  96 

Seaboard  Air  Line  Ry 2,096  734  54 

Atlantic  Coast  Line  R.  R *2,213  *850  *88 

Minneapolis  &  St.  Louis  Ry *2,775  *607  *80 

fPitts.  &  L.  E.  R.  R *2,404  *1,500  *100 

JNew  Orleans,  Mob.  &  Chi.  R.  R *1,952  *692  *64r 

♦Approximate.     fYear  1914.     lYear  1913-14. 


36  A    Railroad   Security 

For  roads  of  Class  1  (having  annual  operating  revenues 
-above  $1,000,000)  for  the  fiscal  year  1914,  the  average  cost  of 
repairs  per  unit  of  equipment  was  as  follows:* 

Locomotives  Freight  Cars  Passenger  Cars 

United  States    $2,812  $80.47  $634.45 

Eastern  District    2,812  81.74  600.19 

-Southern  District    2,759  88.80  757.54 

^Vestern  District  2,836  74.52  637.41 

The  average  cost  of  repairs,  renewals,  and  depreciation  per 
unit  of  equipment  was  as  follows: 

Locomotives  Freight  Cars  Passenger  Cars 

United  States    $3,214  $105.06                 $779.37 

Eastern  District    3,252  107.53                    793.28 

Southern  District    3,142  115.38                    904.02 

Western  District   3,198  96.43                    789.60 

The  figures  for  the  year  1914  are  given  because  they  repre- 
sent what  appears  to  be  a  normal  cost.  Examination  of  main- 
tenance charges  for  war  and  post-war  years  should  simply  take 
into  consideration  the  average  price  advance  and  subsequent 
•decline. 


♦Statistics  furnished  by  Bureau  of  Railway  Economics,  Wasliington,  D.  C. 


CHAPTER   VIII 

TRAFFIC   AND   TRANSPORTATIOX    EXPENSES, 
MISCELLANEOUS   OPERATIONS,    ETC. 

Nature  of  these  Expenses 

As  previously  suggested,  under  these  subdivisions  of  the 
operating  expenses  fall  those  expenses  which,  as  distinct  from 
Maintenance  of  Way  and  Maintenance  of  Equipment,  must  be 
taken  as  in  large  part  being  in  the  nature  of  a  fixed  or  obligatory 
charge.  They  relate  and  are  incident  to  the  immediate  conduct 
of  the  road's  business,  and  like  those  commonly  called  "fixed 
charges"  —  interest,  taxes  and  rentals — their  payment  cannot 
long  be  delayed.  If  a  road  is  hard  pressed,  means  may  be 
found  whereby  the  payment  of  a  portion  of  these  expenses  can 
be  postponed  but  only  for  a  short  time.  In  the  discussion  as  to 
maintenance  expenses  it  was  made  clear  that  those  expenses 
are,  under  necessity  or  in  the  discretion  of  the  management, 
capable  of  curtailment.  It  will  be  found  that  the  amount  per 
mile  of  the  Transportation  Expenses  has  a  general  relation  to 
the  traffic  density.  This  results  from  the  fact  that  these  ex- 
penses depend  largely  upon  the  train  mileage;  engine  mileage 
also  is  an  important  factor,  x^s  density  increases,  other  things, 
as  trainload  and  carload,  being  equal,  the  train  mileage  increases. 

Essentials  to  Consider 

To  the  average  investor  the  essential  thing  to  consider  is 
the  percentage  of  Operating  Revenues  required  for  these  groups 
of  Operating  Expenses.  Where  this  and  the  percentage  of 
Gross  required  for  Fixed  Charges  is  given,  it  is  seen  what  remains 
for  maintenance  and  dividends.  The  questions  of  train  and 
engine  mileage,  train  and  car  loading,  ton  and  train  mile  cost, 
and  earnings,  etc.,  are  of  extreme  interest  and  should  be  care- 
fully dealt  with.     These  will  be  passed  over  here  in  favor  of  the 


447468 


38  A    Railroad   Security 

more  vital  considerations  which  reflect  all  these  —  the  bearing 
of  operating  expenses  (other  than  maintenance)  upon  gross 
earnings.  It  is  not  far  from  the  truth  to  say  that,  for  all  the 
railroads  in  the  United  States,  these  expenses  did  not  require 
for  the  year  1915-16  more  than  40  per  cent  of  the  total  gross 
earnings.  War  conditions  and  Federal  operation  naturally 
altered  later  statistics  but  there  is  now  (1924)  being  witnessed, 
a  gradual  return  to  normal. 

Traffic,  Miscellaneous  Operations,  and  General  Expenses 
have  no  such  relation  to  traffic  density  as  have  the  Transporta- 
tion Expenses.  They  tend  to  constancy  and  vary  but  little  with 
the  amount  of  business  done.  These  expenses  are  often  rela- 
tively greater  on  a  small  than  on  a  large  road.  As  Traffic, 
Miscellaneous  Operations,  and  General  Expenses  make  up  but 
a  small  part  of  the  operating  expenses,  and  as  they  partake  of 
the  nature  of  Transportation  Expenses,  as  distinct  from  Main- 
tenance Expenses,  it  is  right  here  simply  to  class  them  with  the 
Transportation  Expenses. 

Two  Roads  Compared 

Where,  in  the  comparison  of  two  roads  with  like  character 
of  business,  it  is  found  that  the  Transportation  Expenses  of  one 
require  a  relatively  larger  percentage  of  gross  than  in  the  case 
of  the  other,  it  means  one  or  both  of  two  things:  either  that, 
with  relatively  like  rates  for  the  work  performed,  the  one  road 
is  not  conducting  its  business  with  the  same  degree  of  economy 
as  the  other,  or  that,  with  like  relative  economy  in  the  conduct 
of  its  business,  the  rates  received  by  it  for  work  performed  are 
relatively  smaller.  In  the  use  here  of  the  word  "economy,"  it 
is  understood  that  the  measure  of  economy  is  net  results. 

To  show  the  significance  of  this  percentage  to  the  investor, 
consult  for  example,  the  records  of  the  Chicago  Great  Western 
and  the  Atchison,  Topeka  and  Santa  Fe.  The  character  of  the 
tonnage  of  these  two  roads  is  very  similar.  For  the  year  ending 
December  31,  1917,  Operating  Expenses  other  than  Main- 
tenance consumed  41.1  per  cent  of  the  Great  Western's  total 
income  against  4»j*C  per  cent  for  the  Atchison.     These  expenses 


:>\2 


Traffic  and  Transportation  Expenses  39 

have  required  a  very  large  percentage  of  the  Great  Western's 
total  income  each  year  for  the  last  ten  years,  and  their  ratio  to 
total  income  has  shown  little  tendency  to  become  less.  When 
it  is  remembered  that  these  expenses  partake  of  the  nature  of 
a  fixed  charge  upon  gross,  the  full  significance  is  apparent. 

Let  it  be  assumed  that  the  annual  interest,  taxes  and  rentals 
had  required  in  1917,  20  per  cent  of  the  gross  for  both  the  Great 
Western  and  the  Atchison.  Of  the  Great  Western's  gross,  then 
61.1  per  cent  would  have  been  consumed  by  these  "fixed" 
charges,  leaving  38.9  per  cent  for  maintenance  and  dividends. 
Of  the  Atchison's  gross,  but  54.2  per  cent  would  have  been  con- 
sumed by  "fixed"  charges  and  45.8  per  cent  would  have  been  left 
for  maintenance  and  dividends.  It  is  clear  that  the  margin  of 
safety  for  dividends  would  have  been  far  greater  for  the  Atchison 
than  for  the  Great  Western.  The  actual  margin  of  safety  for 
the  Atchison  was  greater  than  has  been  indicated  here,  because 
interest,  taxes,  and  rentals  required  only  about  15.4  per  cent  of 
the  1917  total  income  against  24.3  per  cent  for  the  Great 
Western. 

While  the  larger  percentage  of  gross  required  for  these  groups 
of  Operating  Expenses  in  the  case  of  one  road  reflects  what  has 
been  called  "relatively  less  economy"  in  operation,  yet  this  by 
no  means  implies  a  relative  lack  of  efficiency  in  the  management. 
A  railroad  might  be  operated  with  the  highest  degree  of  efficiency, 
yet  the  average  rates  received,  and  consequently  the  gross 
earnings,  might  be  so  small  as  to  make  these  expenses  bear  a 
very  high  ratio  to  the  gross. 

General  Rule 

When  rates,  trainJoads,  etc.,  tend  to  constancy,  the  ratio  of 
Transportation  Expenses  varies  inversely  ivith  Operating  Revenues. 

It  is  shown  in  what  follows  that  the  margin  for  maintenance 
and  dividends  may  be  greater  on  a  road  with  large  Operating 
Revenues  per  mile,  where  the  Operating  Expenses  other  than 
Maintenance  require,  say  42  per  cent  of  the  gross,  than  on  a 
road    with    small    Operating    Revenues    per    mile,    where    those 


40 


A    Railroad  Security 


expenses  require  but  35  per  cent  of  the  gross.  For  the  first  road 
20  per  cent  of  the  gross  might  be  ample  for  maintenance,  while 
35  per  cent  of  its  gross  might  be  an  insufficient  allowance  for  the 
second  road.  The  fact  remains  after  all,  that,  other  things  being 
equal,  where  these  expenses  are  relatively  larger,  the  margin  of 
safety  is  relatively  less. 


^^ 


CHAPTER   IX 
THE   OPERATING   RATIO 

Has  It  Significance? 

What  has  gone  before  leads  naturally  to  the  discussion  of  the 
Operating  Ratio  in  its  bearing  upon  this  question  of  earning 
power.  It  is  with  great  difficulty  that  many  investors  are 
dissuaded  from  the  belief  that  the  Operating  Ratio  counts  for 
all.  Where  a  road  is  reported  as  operating  at  50  per  cent  it  is 
not  uncommon  to  hear  it  said  that  "it  cannot  be  done."  Another 
road  reports  operating  at  75  per  cent,  and  it  is  said  that,  because 
of  this  high  Operating  Ratio,  there  is  manifestly  "abundant 
opportunity  for  curtailment  in  expenses."  It  may  be  stated  at 
once  that  the  Operating  Ratio,  or  the  ratio  which  operating 
expenses  bear  to  gross  earnings,  has  of  itself  no  significance 
whatsoever.     A  few  examples  will  tend  to  establish  this  fact. 

The  gross  earnings  (operating  revenues)  and  operating  ex- 
penses of  roads  "A,"  "B,"  "C,"  "D,"  and  "E,"  may  be  taken  as 
given  in  the  table  on  following  page.  For  the  sake  of  argument, 
it  is  assumed  that  it  required  for  normal  maintenance  of  road 
and  equipment  no  more  "per  mile  of  road"  for  one  of  these  roads 
than  for  another. 

It  is  clear  that  road  "A,"  operating  at  55  per  cent,  makes 
more  liberal  outlay  for  maintenance  than  roads  "B,"  "C,"  and 
"D,"  which  operate  at  60  per  cent,  65  per  cent,  and  75  per  cent, 
respectively.  Consequently  road  "A"  has  greater  room  for 
curtailment  in  its  maintenance.  Road  "A"  includes  in  its 
operating  expenses  sums  in  excess  of  normal  requirements  for 
maintenance,  road  "B"  spends  enough  for  maintenance,  while 
the  expenses  of  "C"  and  "D"  fall  considerably  below  the  average 
requirements.  The  $1,500,000  or  15  per  cent  of  its  gross, 
expended  by  road  "D"  for  Maintenance  of  Way  on  its  5,000- 
mile  road  is  by  far  a  relatively  smaller  outlay  than  that  of 
road  "A,"  where  $1,250,000,  or  but  12^  per  cent  of  its  gross  i&> 


3          c 

o 

o 

o 

05": 

o        c 

:            c 

o 

o 

o         ^ 

o 

o 

o_ 

[0.5 

O           f^                ro 

oT 

w 

mr 

fO 

«i% 

o 

Csio 

O            w 

^ 

o 

^ 

f^l 

o 

^            ^ 

^ 

o 

^ 

^ 

^ 

c"       -- 

c'        C? 

^ 

^ 

- 

>5 

O 

o" 

c        c 

c        o 

o 

<3 

o 

O 

o        c 

O               CN 

o_ 

tTi 

c 

m 

o_ 

H 

O            (~0                f^ 

Q- 

tr 

»n" 

f*^ 

^ 

•,—i 

^^ 

^b3 

CO              o 

(-, 

o 

o 

S?  J 

O            '^ 

c 

o 

o 

o 

O            r^                rc 

o^ 

m 

in 

^i 

4^ 

o   , 

Qo 

o        o           c 

c 

c 

o 

< 

O 

o        o           c 

c 

c 

o 

in 

c        c 

X-      ^ 

o' 

S:5 

c 
c 

- 

&? 

o 

o        c 

c        o 

c 

>i^ 

c 

lO 

o 

O            "~-                li",           r'j 

to 

Tf 

l/- 

I^ 

in 

H 

O                 -r- 

'-I 

^ 

J> 

cn" 

€© 

^'^^ 

o         o            c; 

o 

c 

o 

c         o 

c 

lO 

\r 

•n 

^^1 

C_          lO                Lr, 

cs_ 

fs 

t--_ 

iC~ 

CN 

r<- 

Y-H 

^ 

o 

O            w 

c 

o 

^ 

o 

O            '^ 

o 

^ 

X"       X 

-    1  ^ 

o_ 

o" 

^ 

c 
c 

- 

fe5 

o" 

O 

O                    w 

c        c 

c 

lo 

in 

o 

C           C: 

C_            <M 

l/~. 

■* 

LT 

o 

in 

^^- 

— 

rf 

vC 

(^ 

R 

CO              o 

o 

o 

O           ir 

in 

o 

o 

O           1^ 

l^ 

lo 

C 

^ 

o 

o" 

rlr 

o 

^~ 

s 

s 

»>  o 

°   ^ 

c        c 

c 

o 

c 

o 

c        c 

c 

o 

c 

Q 

< 

c        c 
o"        c 

c       e- 

c__ 

&5 

o 

- 

&5 

o_ 

O 

c          u- 

""-             "0 

Q 

in 

^ 

o 

o 

O           t^ 

t^        — 

"1 

rf 

c 

^ 

o 

o 

o" 

'*" 

^ 

TjT 

€^ 

g| 

c        o 

3 

o 

c 

c 

O            1^ 

ij^ 

o 

c 

o 

C           f^ 

CVI 

o_ 

u- 

in 

^^ 

O"                  '-H 

■,-h" 

r^ 

u- 

" 

tJh" 

e 

<^ 

<§ 

C         c 

c 

c 

c 

o 

^ 
^ 
P 

o 

o 

"^ 

o^       c 
c'       o 

-     1    t? 

o_ 

^^ 

c 

- 

^ 

o 

o" 

o        "- 

\n          Lo 

c 

C 

c 

in 

o 

o         ^ 

r-i          CN 

o_ 

ro 

l/- 

in 

in 

o"        — 

1— ( 

ro 

Lr 

'* 

^ 

w-o 

V)    -~. 

U~*                      1 

u 

>'>        •    ■« 

&<    '^ 

tc 

CiO 

to 

0)    o 

o     .    ^     . 

CI 

X 

^ 

»*     t^ 

s; 

<o 

3 

c 
p 

■^1 

j: 

la 

« 

•  t:    c; 

•  = 

■a 

—  a 

O 

1  ;3 

rt 

"5 

CO 

is 

be    rt 

c 
o 

M 

-Ci,    — 

5j 

a 
O 

^ 

•OO 

C 

c 

1-  c 

2   =  .^ 

"^ 

C 

••2 

5j 

u 

s.'5  ?: 

rt  W  -5   8 

rt 

C   a;5 

O  ''2l 

o 

U. 

"5 

t: 

a> 

c  S 

^       Q< 

H 

o< 

L^ 

Ci 

2 

operating    Ratio  43- 

so  expended  on  1,000  miles  of  road.  Now,  take  road  "E."  It 
is  seen  that  while  Traffic  and  other  Operating  Expenses  require- 
the  same  percentage  of  Operating  Revenues,  "E,"  operating  at 
50  per  cent,  spends  for  maintenance  140  per  cent  more  than 
"A,"  which  is  operated  at  55  per  cent.  The  table  explains 
itself.  It  is  unnecessary  to  give  more  examples  (many  more 
might  be  gi\'en)  to  show  that  the  Operating  Ratio  of  itself  is  of 
no  significance.  Wherever  it  may  have  significance  it  will  be 
found  to  be  wholly  the  result  of  accident. 


"Rules,"  with  Qualifications 

Were  it  not  for  the  diverse  conditions  which  affect  peculiarly 
the  question  of  maintenance  in  each  individual  road,  it  might  be 
possible  to  arrive  at  certain  definite  rules  as  to  the  percentage 
of  gross  required  for  maintenance  in  difTerent  classes  of  railroads. 
One  rule  would  suggest  itself  somewhat  as  follows  under  normal 
conditions:  that  for  average  maintenance  requirements  for 
Southern  and  Western  roads  the  Operating  Revenues  of  which 
amount  to,  say  $9,000  per  mile,  an  annual  appropriation  of 
from  25  per  cent  to  28  per  cent  of  the  gross,  would,  under  normal 
conditions,  be  ample.  Another  rule  might  be  found  to  apply 
to  such  roads  as  the  Central  of  New  Jersey,  the  Delaware,. 
Lackawanna  and  Western,  etc.,  to  the  effect  that,  where  gross 
earnings  exceed  $40,000  per  mile,  an  appropriation  of  from  17 
per  cent  to  20  per  cent  of  gross  would  be  more  than  sufficient 
for  average  maintenance  requirements.  The  mere  statement 
of  any  "rule"  must  of  necessity  be  clothed  with  many  exceptions 
and  modifications  but  it  is  valuable  for  use  as  a  base  for  logical 
reasoning. 


CHAPTER   X 
FIXED   CHARGES 

Suggested  Examinations 

Under  Fixed  Charges  falls  interest  on  the  funded  and  floating 
debt,  rentals  of  leased  lines  —  embracing  guaranteed  dividends, 
etc.  —  taxes  and,  in  some  cases,  sinking-fund  payments.  (The 
Interstate  Commerce  Commission  directed  that,  beginning 
July  1,  1907,  taxes  are  to  be  deducted  from  operating  income 
and  not  included  either  in  Fixed  Charges  or  in  Operating  Ex- 
penses. In  this  text  taxes  are  included  in  Fixed  Charges.) 
The  investor  should  examine  the  annual  report  carefully  to 
ascertain  whether  or  not  the  full  interest  on  all  the  bonds  out- 
standing at  the  close  of  the  fiscal  period  has  been  charged  in  the 
Income  Account  for  the  period  under  review.  Another  im- 
portant suggestion  which  may  be  made  here  is  that  the  investor 
looks  to  ascertain  ivhat  the  situation  may  be  in  the  case  of  this  or 
that  road  for  future  saving  or  increase  in  i^iterest  charges  through 
refunding. 

Very  few  roads  are  required  today  to  set  aside  each  year 
from  earnings  specific  amounts  for  sinking  fund  purposes.  The 
Chicago,  Burlington  and  Quincy's  annual  appropriation  for 
sinking  funds  is  today  relatively  larger  than  that  of  any  other 
railroad  in  this  country,  excepting  where  annual  payments  are 
made  in  the  retirement  of  short-time  .serial  bonds.  For  the 
year  ending  December  31,  1917,  the  sinking  fund  payments  of 
the  Chicago,  Burlington  .and  Quincy,  amounted  to  $1,397,031. 
As  such  appropriations  are  in  their  nature  extraordinary,  and 
are  used  for  the  retirement  of  obligations  of  the  company,  they 
must  be  given  due  weight  in  the  comparison  of  the  respective 
earning  power  of  different  roads. 


Fixed   Charges  45 

Significance  of  Item 

As  there  is  of  itself  little  significance  in  the  comparison  of  the 
average  trainloads  or  average  train  miles,  and  as  there  is  of 
itself  no  significance  in  the  comparison  of  the  Operating  Ratio 
of  different  roads,  so  from  the  investor's  standpoint,  there  is 
necessarily  no  significance  to  be  attached  to  the  fact  that  one 
road  has  a  bonded  debt  of  $30,000  per  mile,  while  the  bonds 
outstanding  on  another  road  amount  to  but  $15,000  per  mile. 
Likewise,  the  fact  alone  that  the  fixed  charges  of  one  road  amount 
to  $10,000  per  mile  of  road  against  $2,000  per  mile  on  another 
shows  by  no  means  that  the  bonds  of  the  latter  are  more  secure. 
The  essential  consideration  here  —  as  in  the  case  of  those  quasi- 
fixed  charges,  the  Operating  Expenses  other  than  Maintenance  — 
is  the  ratio  which  these  charges  bear  to  Operating  Revenues 
and  the  ability  of  the  road  to  pay  these  charges.  It  stands  to 
reason  that  the  New  York  Central  with  say  $40,000  per  mile  gross 
receipts,  could  more  easily  provide  for  the  interest  on  bonds 
aggregating  say  $60,000  per  mile  than  the  St.  Louis  and  San 
Francisco,  with  $11,000  per  mile  gross  could  provide  for  interest 
on  a  bonded  debt  of  say  $30,000  per  mile. 

It  demands  no  proof  to  show  that  fixed  charges  of  $600  per 
mile  on  one  road  might  be  a  heavier  burden  on  earnings  than 
fixed  charges  of  $1,000  per  mile  on  another,  although  in  each 
case  the  percentage  of  gross  required  for  these  charges  is  but 
20  per  cent.  Take  as  Operating  Revenues  for  the  first  road 
$3,000  per  mile,  and  for  the  second  $5,000  per  mile.  Let 
Operating  Expenses,  other  than  Maintenance,  require  35  per 
cent  of  the  gross  for  each  road.  Here  is  55  per  cent  of  gross 
consumed  by  "fixed"  charges  in  each  case.  The  one  road  has 
45  per  cent  of  $3,000  per  mile,  or  $1,350  per  mile  for  mainte- 
nance and  surplus;  the  other  has  45  per  cent  of  $5,000  per  mile, 
or  $2,250  per  mile  remaining  for  maintenance  and  surplus. 

Fixed  Charges  as  an  Investment  Test 

As  a  rule,  where,  on  a  basis  of  earnings  such  as  these  have 
averaged  in  recent  years,  the  fixed  charges  of  any  given  road 


46  A    Railroad   Security 

have  required  less  than,  say,  22  per  cent  of  total  income,  and 
where  the  surplus  after  the  payment  of  all  operating  expenses 
(including  liberal  outlays  for  maintenance),  have  amounted  to 
not  less  than,  say,  17  per  cent  of  the  total  income,  the  interest 
on  the  road's  bonds  may  be  considered  very  secure.  It  should 
be  noted  that  this  is  not  the  same  situation  as  would  be  pre- 
sented were  it  stated,  for  example,  that  the  interest  is  secure 
where  the  fixed  charges  require,  say,  50  per  cent,  or  less  of  the 
net  income,  for  the  reason  that  operating  expenses  (including 
proper  outlay  for  maintenance)  might  in  one  case  require  90 
per  cent  of  the  gross  income  against  60  per  cent  in  another  case. 
The  fixed  charges  in  the  first  case  might  require  but  50  per  cent 
of  the  net,  or  5  per  cent  of  the  gross  income;  in  the  second  case 
they  might  require,  likewise,  50  per  cent  of  the  net,  or  20  per 
cent  of  the  gross  income.  Should  the  gross  income  show  a 
proportional  decrease  of,  say  15  per  cent  for  each  road,  other 
things  being  equal,  one  road  would  show  a  deficit  after  fixed 
charges,  while  the  other  road  would  show  a  surplus. 

The  percentage  of  fixed  charges  varies  in  an  inverse  ratio 
with  gross  earnings. 


Comparison  of  Two  Railroads 

Observe  the  following  tables  wherein  are  given  the  income 
accounts  of  roads  "A"  and  "B,"  the  figures  being  stated  both  in 
full  and  reduced  to  a  "per  mile"  basis. 


TABLE  I 

A 

Miles  Operated    1,000 

Operating  Revenues    $10,000,000 

Operating  Expenses     6,000,000 

Net  Operating  Revenues    . .  4,000,000 

Fixed  Charges    2,000,000 

Ratio  of  Fixed  Charges  to  Gross  20  % 

Surplus    2,000,000 


B 

1,000 

810,000 

$10,000,000 

$10,000 

6,000 

6,000,000 

6,000 

4,000 

4,000,000 

4,000 

2,000 

3,000,000 
30% 

3,000 

2,000 

1,000,000 

1,000 

Si, 250,000 

SI, 250 

1,250,000 

1,250 

25% 

3,000,000 

3,000 

Fixed   Charges  47 

operating  Expenses 

Maintenance  of  Way    $1,250,000       $1,250 

Maintenance  of  Equipment  1,250,000          1,250 

Ratio  of  Maintenance  to  Gross  25  % 

Traffic   and   Transportation  3,000,000         3,000 
Miscellaneous       Operations 

and  General  Expenses    . .  500,000            500                500,000            500 
Ratio   of   Traffic   and  Other 

OperatingExpenses  toGross  35%                                      35% 


In  the  above  comparison  of  the  income  accounts  of  roads 
"A"  and  "B"  the  operating  expenses  are  in  every  respect  alike. 
The  fixed  charges  of  road  "A"  require  20  per  cent  of  the  gross 
and  of  road  "B"  30  per  cent  of  the  gross.  The  surplus  of  "A" 
amounts  to  $2,000,000  and  that  of  "B"  to  $1,000,000. 

Assume  that  operating  revenues  decrease  25  per  cent,  and 
that  roads  "A"  and  "B"  are  operated  as  before  at  60  per  cent. 
The  income  accounts  would  appear  somewhat  as  follows: 


TABLE  II 

A  B 

Miles  Operated    1,000  1,000 

Operating  Revenues    $7,500,000  S7,500           $7,500,000       $7,500 

Operating  Expenses     4,500,000  4,500             4,500,000         4,500 

Net  Operating  Revenues    .  .         3,000,000  3,000             3,000,000         3,000 

Fixed  Charges    2,000,000  2,000             3,000.000         3,000 

Ratio  of  Fixed  Charges  to  Gross             26.6%  40% 

Surplus    1,000,000  1,000             0,000,000         0,000 


Operating  Expenses 

Maintenance  of  Way    $950,000          $950 

Maintenance  of  Equipment  700,000            700 

Ratio  of  Maintenance  to  Gross  22  % 

Traffic   and    Transportation  2,350,000         2,350 
Miscellaneous       Operations 

and  General  Expenses     .  .  500,000            500                 500,000            500 
Ratio    of    Traffic    and    other 

OperatingExpenses  toGross  38%                                      38% 


$950,000 

$950 

700,000 

700 

22% 

2,350,000 

2,350 

48  A    Railroad   Security 

Here  Maintenance  Expenses  are  curtailed;  Traffic  and 
Transportation  Expenses,  while  requiring  a  greater  percentage 
of  gross,  are  smaller,  due  to  less  business  handled;  and  Mis- 
cellaneous Operations  and  General  Expenses  remain  the  same. 
The  fixed  charges  remain  the  same  and  they  require  26.6  per 
cent  of  road  "A's"  gross  and  40  per  cent  of  road  "B's"  gross. 
The  percentage  of  gross  required  for  "B's"  fixed  charges  is  10 
per  cent  greater  than  in  the  example  given  first  above,  while 
the  percentage  required  for  "A's"  fixed  charges  is  about  6.6  per 
cent  greater  than  it  was  before  the  earnings  decreased.  Road 
"A"  shows  $1,000,000  surplus,  while  "B's"  surplus  is  entirely 
wiped  out. 


CHAPTER   XI 

STOCK  OUTSTANDING   IN   ITS   RELATION   TO 
EARNING   POWER 

Integrity  of  Net  Earnings  and  Surplus 

What  has  gone  before  shows  that  a  railroad's  earning  power 
cannot  be  measured  by  the  surpkis  alone.  Analysis  of  the  Main- 
tenance Expenses  indicates  the  integrity  of  the  net  earnings, 
and  consequently  the  integrity  of  the  surplus.  Where  main- 
tenance is  found  to  be  insufficient,  the  investor  knows  that 
earnings  must  be  drawn  upon  to  a  greater  extent,  and  that  if 
the  gross  is  not  large  enough  to  allow  of  a  greater  appropriation, 
future  increases  in  earnings  must  be  used,  so  far  as  they  may  be, 
to  bring  the  maintenance  outlay  up  to  fair  requirements.  W^here 
maintenance  is  found  to  be  ample  or  to  exceed  normal  require- 
ments, the  investor  knows  that  a  future  increase  in  earnings 
may  rightly  be  reflected  in  a  larger  surplus. 

A  comparison  of  the  results  of  two  companies,  say.  Railroad 
No.  1  and  Railroad  No.  2,  is  instructive  as  illustrating  this 
point.  The  maintenance  expenses  of  the  former  road  for  years 
prior  to,  say,  1916  were  far  below  normal  requirements,  while 
Railroad  No.  2  for  years  charged  its  expenses  very  fairly. 
Owing  to  its  large  annual  fixed  charges  Railroad  No.  1  found  it 
impossible  to  appropriate  a  greater  percentage  of  its  gross  for 
maintenance.  For  the  year  1916  both  of  the  lines  showed  large 
increases  in  earnings.  The  greater  part  of  the  increase  of 
Railroad  No.  1  was  diverted  to  the  maintenance  accounts,  while 
the  increase  in  the  earnings  of  Railroad  No.  2  was  for  the  most 
part  carried  into  net  earnings.  Many  railroads  can  safely 
cause  a  reduction  in  their  maintenance  expenses  and  thus  add 
largely  to  their  surplus;  for  example,  the  maintenance  expenses- 
in  certain  years  of  the  Delaware,  Lackawanna  and  Western, 
and  of  the  Pittsburgh  and  Lake  Erie  were  far  above  the  necessary 
average  requirements. 


50  A    Railroad  Security 

Margin  of  Safety 

It  has  been  demonstrated  also  in  the  foregoing  chapters  that 
where  the  Operating  Expenses  other  than  Maintenance,  or 
where  Fixed  Charges  are  a  relatively  heavy  burden  on  gross 
earnings,  the  margin  of  safety  represented  in  the  surplus  is 
relatively  small.  For  exactly  those  reasons  that  make  greater 
or  less  the  margin  of  safety  represented  in  a  road's  surplus,  it 
follows  that  the  margin  of  safety  for  dividends  for  one  road  which 
earns  10  per  cent  on  its  capital  stock  is  necessarily  by  no  means 
so  great  as  that  for  another  road  which  also  earns  10  per  cent  on 
its  stock. 

The  capital  stock  of  road  "A,"  the  Income  Account  of  which 
was  given  on  Page  46  (Table  I),  is,  let  us  say,  $20,000,000  and 
that  of  "B,"  $10,000,000.  While  each  road  earned  10  per  cent 
on  its  stock,  yet  it  is  shown  in  Table  II,  Page 47,  that  with  like 
decreases  in  gross  earnings,  "A"  earned  5  per  cent  on  its  stock 
and  "B"  earned  nothing  at  all.  So  the  amount  earned  on  the 
stock  of  one  road  might  equal  15  per  cent,  and  yet  the  margin  of 
safety  might  not  be  so  great  as  in  the  case  of  another  road  where 
but  10  per  cent  was  earned. 

An  earning  power  of  10  per  cent  on  Mobile  and  Ohio  stock, 
or  on  Missouri,  Kansas  and  Texas  preferred,  means  far  less  as 
to  the  margin  of  safety  for  dividends  than  does  an  earning 
power  of  10  per  cent  on  Illinois  Central  stock,  Chicago,  Burlington 
and  Quincy  stock,  or  Louisville  and  Nashville  stock. 

In  any  comparison  of  the  earning  power  of  two  roads,  it  is 
important  to  note,  in  connection  with  other  essential  facts, 
what  percentage  of  the  operating  revenues  is  required  to  pay 
one  per  cent  on  the  stock  of  each. 

The  capital  stock  of  the  New  York,  Ontario  and  Western, 
which  operates  about  568  miles  of  road,  is  about  as  large  as  that 
•of  the  Chesapeake  and  Ohio,  which  operates  2,412  miles  of 
road.  The  gross  earnings  of  these  roads  were  approximately, 
$16,500  and  $23,000  per  mile,  respectively,  for  the  year  ending 
December  31,  1917.  Inasmuch  as  the  total  gross  earnings  of 
the  New  York,  Ontario  and  Western  for  that  year  was  not  over 


S  t  0  ck   0  lit  s  tanding  51 

16  per  cent  on  its  capital  stock,  it  must  be  a  long  time  before 
the  earning  power  of  the  road  will  warrant  a  high  price  for  the 
stock. 

Earning  Power 

That  the  rate  of  dividends  paid  on  a  road's  stock  does  not 
determine  the  value  of  that  stock  is  evidenced  as  well  by  the 
market  value  of  such  stocks  as  Central  R.  R.  of  New  Jersey  and 
"Lackawanna"  as  by  the  comparatively  recent  market  value 
of  such  a  stock  as  Great  Northern  Preferred  or  Missouri  Pacific. 
The  value  of  a  stock  is  usually  determined  by  the  earning  power 
rather  than  the  desire  of  the  road  to  pay  dividends.  This 
earning  power  is  determined  not  only  by  the  margin  of  safety 
represented  in  the  surplus,  but  also  by  the  stability  or  lack  of 
stability  of  the  operating  revenues.  The  character  of  the 
tonnage  and  the  natural  resources  and  development  of  the 
territory  traversed  are  to  be  considered  in  their  bearing  upon 
the  stability  of  the  road's  traffic. 

Certainly  the  earnings  for  any  one  year  cannot  be  taken  as 
demonstrating  a  road's  ability  to  pay  its  interest  or  to  pay 
dividends.  The  investor  must  consider  the  course  of  earnings, 
for  a  series  of  years  as  well  as  the  prospects  for  the  future. 

Financing  Policies 

He  must  recall,  when  comparing  the  earning  capacity  of 
Illinois  Central  with  that  of  Chesapeake  and  Ohio,  that,  while 
each  of  these  roads  may  be  earning  10  per  cent  on  its  present 
outstanding  capital  stock,  the  capital  stock  of  Illinois  Central 
includes  about  $50,000,000  stock  sold  during  recent  years  at 
par,  the  proceeds  from  the  sale  of  which  were  used  for  improve- 
ments. No  part  of  the  present  outstanding  stock  of  the  Chesa- 
peake and  Ohio  represents  stock  sold  by  the  company  for  cash. 
Nearly  tw^o-thirds  of  the  outstanding  capital  stock  of  the  Penn- 
sylvania Railroad  has  been  sold  for  cash  during  the  past  twenty 
years  at  considerably  above  its  par  value,  and  over  two-thirds 
of  the  outstanding  common  stock  of  the  Baltimore  and  Ohio- 


52  A    Railroad  Security 

has  been  sold  at  par.  The  Chicago,  Milwaukee  and  St.  Paul, 
Great  Northern,  Canadian  Pacific,  Southern  Pacific,  and  many- 
other  companies  have  secured  large  sums  for  improvements, 
•etc.,  by  the  sale  of  capital  stock. 


Basis  of  Earning  Power 

It  must  be  said,  finally,  (as  has  been  suggested  in  what  has 
gone  before)  that  absolute  knowledge  concerning  the  value  of 
railroad  securities  can  be  gained  only  by  a  careful  and  personal 
•examination  of  the  physical  condition  of  each  property,  as  well 
as  of  the  traffic  relations  and  advantages  and  the  conditions 
attaching  to  the  same.  In  this  way  knowledge  can  be  gained  as 
to  the  opportunities  presented  in  each  case,  both  for  the  better 
handling  of  business  already  secured  and  for  the  securing  of 
new  business. 

However,  sufficient  relative  knowledge  can  be  gained  from 
a  careful  consideration  of  the  items  treated  here,  so  that  the 
investor  can  stand  on  his  own  feet,  speaking  figuratively, 
and  discriminate  between  those  railroads  whose  securities  ofler 
opportunities  for  successful  investment  and  those  which  lack 
promise. 


CHAPTER   XII 
CONCLUDING   OBSERVATIONS 

What  May  Readily  Be  Gained? 

The  client  who  studies  railroad  reports  in  the  way  which 
has  now  been  outlined  comes  to  know  certain  essentials  con- 
cerning the  value  of  a  railroad  security,  the  lack  of  which  has 
been  responsible  for  many  of  the  dif^culties  with  which  investors 
have  been  beset.  Perhaps  it  may  prove  helpful  in  conclusion 
to  specify  briefly  certain  of  these  essentials: 

1.  The  comparison  of  gross  earnings  per  mile  of  a  small  road  with  those 
of  a  large  road,  even  though  these  roads  extend  through  similar  territory, 
does  not  prove  the  safety  of  a  security. 

The  road  of  8,000  miles  may  have  several  thousand  miles  of  branches, 
traversing  sparsely  settled  districts,  so  that  the  average  earnings  per  mile 
may  be  smaller  than  those  of  the  1500-mile  road,  which  has  no  branches  and 
traverses  thickly  settled  districts. 

2.  The  facts  concerning  book  value  of  the  company's  property  must  not 
be  permitted  to  obscure  other  facts  more  important. 

Book  value  of  itself  indicates  nothing  as  regards  the  value  of  the  company's 
bonds  and  stocks. 

3.  The  surplus  earnings  for  one  year  or  the  average  surplus  earnings  for  a 
number  of  years,  do  not  provide  an  adequate  basis  upon  which  conclusions 
may  be  drawn. 

The  surplus  of  every  year  should  be  exhibited  and  the  gross  earnings  and 
fixed  charges  as  well. 

4.  The  statement  that  the  company's  profit  and  loss  account  shows  a 
credit  balance  of,  say,  $10,000,000  cannot  be  considered  conclusive. 

Perhaps  the  balance  sheet  shows  that  $10,000,000  is  carried  among  the 
assets  of  the  company  representing  unextinguished  discount  on  securities  sold. 

5.  Statements  that  10  per  cent  is  being  earned  on  the  stock,  or  that  5  per 
cent  is  being  paid  on  the  stock,  or  that  the  interest  on  a  particular  issue  of 
bonds  is  being  earned  several  times  over,  though  facts,  need  examination. 

The  company  may  be  earning  several  times  the  amount  required  to  pay 


54  A    Railroad  Security 

the  interest  on  a  certain  underlying  issue  of  bonds,  and  at  the  same  time  may 
be  reporting  a  deficit  after  paying  the  interest  on  all  the  issues  of  its  bonds. 

6.  The  fact  that  the  entire  fixed  charges  of  the  company  amount  to  only 
S500  or  §1,000  per  mile,  or  that  the  bonded  debt  of  the  company  is  only 
810,000  per  mile,  against  $50,000  per  mile  in  the  cases  of  other  companies 
whose  bonds  are  recognized  as  proved  investments,  does  not  in  itself  prove 
the  soundness  of  a  securit3\ 

Earning  capacity  is  what  counts,  as  determined  by  the  margin  of  safety 
test. 

7.  The  view  that  a  "bond"  is  safer  than  a  stock  must  not  be  accepted 
uncritically. 

Some  stocks  are  far  safer  than  many  bonds.  If  intrinsic  value  is  deter- 
mined by  earning  capacity,  or  the  ability  to  pay,  and  if  an  investment  is  to  be 
chosen  or  discarded  because  of  its  value  or  absence  of  value  so  determined  and 
not  by  the  interest  and  dividend-producing  quality,  then  there  can  remain  no 
question  of  the  permanent  advantage  as  an  investment  possessed  by  good 
railroad  stocks  over  a  large  class  of  railroad  bonds. 

What  Must  be  Emphasized? 

These  all  point  to  one  fiuidamental  truth,  that  a  security 
has  to  be  judged  individually  on  its  merits.  The  methods 
for  doing  this  have  been  pointed  out  in  the  preceding  chapters. 

Statistics,  while  by  no  means  all  conclusive  in  determining 
values,  undoubtedly  give  an  insight  to  the  truth,  and,  rightly 
used,  they  will  be  found  most  helpful  to  all  investors. 

Is  New  Era  Dawning? 

These  statistical  examinations,  described  in  the  preceding 
chapters,  prove  more  useful  when  the  results  they  reveal  are 
interpreted  correctly,  from  the  viewpoint  of  the  railroad  problem 
and  business  conditions  as  a  whole.  Certain  fundamentals  in 
the  railroad  problem  were  sketched  in  Chapter  I,  and  the  question 
now  is  raised,  what  is  the  long-range  outlook  for  the  railroads? 

The  era  of  railroad  pioneering  and  development  witnessed 
financial  interests  operating  with  a  free  hand.  Gradually, 
however,  the  conviction  began  to  take  shape  that  these  financial 
magnates  were  diverting  an  undue  proportion  of  the  funds  in- 
volved to  their  own  profit.  Public  opinion,  with  the  aim  of 
safeguarding  the  public  interest,  adopted  the  attitude,  expressed 


C  0  71  dud  in  g   Observations  55 

in  numerous  legal  regulations,  hostile  propaganda,  court  deci- 
sions, etc.,  of  "thus  far  thou  shalt  go,  but  no  farther." 

The  shippers,  likewise,  though  the  issue  has  long  been 
befogged,  have  discovered  that  public  opinion  now  has  become 
too  well  informed  to  tolerate  an  unjustified  diverting  of  railroad 
resources  to  them.  Rates,  henceforth,  are  likely  to  be  regarded 
not  as  a  "rake-off"  for  some  corporation  but  a  matter-of-fact 
payment  for  services  rendered. 

The  situation  with  respect  to  labor  is  even  more  convincing, 
for  public  sympathy  naturally  sides  with  men  rather  than  prop- 
erty and  has  looked  with  satisfaction  for  years  upon  the  steady 
improvement  in  their  conditions  of  labor  won  by  the  strongly 
unionized  railroad  employes. 

The  suppliers  of  railroad  commodities,  the  sellers  of  rails, 
rolling  stock,  etc.,  to  come  now  to  the  last  factor  —  are  they 
to  continue  exempt,  to  charge  what  they  can;  or  will  the  same 
searching  question  which  has  been  applied  to  financial  interests, 
shippers,  and  labor,  also  be  applied  to  them:  "What  is  reason- 
able?" We  think  that  this  will  be  the  case,  and  there  are  indi- 
cations already  that  these  suppliers  of  commodities,  when  they 
deal  with  companies  providing  the  country's  transportation 
service,  will  have  to  pass  satisfactorily  tests  of  fairness  now  only 
in  the  process  of  being  evolved. 

Future  Possibilities 

Such  would  seem  to  be  the  logical  outcome  under  such 
railroad  legislation  as  the  Esch-Cummins  Bill  known  as  "the 
Railroad  Act  of  1920."  This  act  provided  that  the  rates  of  the 
railroads  should  be  put  on  a  basis  that  would  allow  a  return  of 
between  5|%  and  6%  on  the  total  invested  capital.  It  was  not 
intended,  and  subsequent  developments  have  shown  that  this 
does  not  mean  that  every  road  should  earn  this  figure  on  its 
outstanding  capitalization.  The  railroads  that  have  charged 
large  amounts  to  maintenance  over  a  period  of  years  and  have 
thus  built  up  their  properties  in  that  fashion  rather  than  through 
continued  issuance  of  new  securities  are  finding  that  invested 
capital    is    in    excess    of    the    bond    and    stock    capitalization 


56  A    Railroad   Security 

outstanding.  Roads  of  that  type,  Atchison  for  illustration,  are 
thus  able  —  after  allowing  for  bond  interest  —  to  show  earnings 
of  better  than  $10  a  share  on  their  stock  while  not  earning  a 
return  of  over  6%  on  their  actual  invested  capital. 

All  earnings  above  6%  are  to  be  divided  on  an  equal  basis 
with  the  Government.  The  Government's  proportion  of  such 
goes  to  the  aid  of  weaker  roads.  In  1920  and  1921  owing  to 
continued  high  operating  costs  and  the  industrial  readjustment 
prevailing,  the  roads  as  a  whole  failed  to  show  anywhere  near 
the  6%  return  allowed.  For  the  year  1921,  for  example,  the 
average  return  of  all  the  roads  in  the  country  was  between  2|% 
and  3%  on  the  average  estimated  invested  capital.  Under 
normal  conditions,  based  on  the  trial  already  given  the  "Railroad 
■Act  of  1920,"  it  is  to  be  believed  that  the  railroads  can  ultimately 
earn  the  stipulated  return  without  difficulty. 

When  a  stable  condition  has  developed,  the  next  step  will 
doubtless  be  a  closer  scrutiny  of  the  expenditures  of  the  various 
railroad  companies.  This  must  be  so,  because  the  bill  as  drawn 
is  somewhat  in  the  nature  of  a  "service-at-cost  plan."  If  ex- 
penses are  allowed  to  grow  at  will  —  maintenance  expenditures  in 
particular  —  earnings  covered  up  might  well  be  in  excess  of  the 
6%  allowed  by  the  Law. 

This  is  what  leads  us  to  feel  that  ultimately  the  supervision 
extended  over  our  railroad  companies  must,  in  part  at  least,  be 
extended  to  those  industries  which  supply  the  commodities 
used  by  the  railroads.  This  is  so  already  in  the  case  of  labor, 
which  is  under  the  direct  supervision  of  the  Railroad  Labor 
Board,  an  outgrowth  of  the  Old  War  Labor  Board.  While  such 
supervision  is  for  the  protection  of  Labor,  the  supervision 
outlined  above  will  be  for  the  protection  of  the  railroad  user  — 
the  public. 

All  this,  viewing  the  matter  broadly,  represents  a  process  of 
socialization,  of  bending  private  interests  to  the  service  of  the 
public  good.  This  process,  while  it  does  not  in  the  long  run  add 
speculative  flavor  to  railroad  securities,  does  a  very  great  deal 
to  assure  them  sound  investment  standing. 


APPENDIX  I 

TEST   QUESTIONS 
THE   VALUE   OF  A   RAILROAD   SECURITY 

All  the  Test  Questions  can  be  answered  directly  from 
the  Text  discussion.  You  will  find  them  helpful  for 
purposes  of  review. 

1.  Who  are  the  parties  at  issue  in  the  railroad  problem? 

2.  State  briefly  the  essentials  of  the  recent  railroad  legisla- 
tion. 

3.  Upon  what  fundamentally  does  the  value  of  a  railroad 
security  depend? 

4.  Are  railroad  reports  more,  or  less,  uniform  than  those  of 
industrials?     Why? 

5.  What  various  items  are  included  in  the  railroad's  income 
account? 

6.  Into  which  account  would  each  of  the  following  items  go: 
Repairs  to  locomotives?  Salary  of  a  General  Passenger  Agent? 
Wages  of  an  engineer?  Painting  a  station?  Interest  upon 
bonds? 

7.  From  what  sources  can  investors  secure  railroad  statistics? 

8.  Define  "operating  ratio."  Does  it  provide  an  essential 
test? 

9.  What  is  meant  by  the  margin  of  safety? 

10.  Specify,  and  explain,  the  seven  important  suggestions, 
and  cautions  listed  for  investors. 


APPENDIX  II 

ANALYSIS   OUTLINE   FOR   RAILROAD   SECURITIES 

This  Analysis  Outline  is  given  you  to  enable  you  to 
judge  the  soundness  and  progress  of  a  Railroad  enter- 
prise. All  the  factors  outlined  below  should  be  answered 
to  your  satisfaction  under  the  principles  set  forth  in  the 
text  on  "Railroad  Securities." 

A.  The  Property 

1.  Location 

2.  Character  of  Traffic 

3.  Long  or  Short  Haul 

4.  Freight  Density 

B.  Capitalization 

L  Bonded  Debt  per  mile 

2.  Stock  Outstanding  per  mile 

3.  Percent  of  Capital,  Bonds —  Percent,  Stock 

C.  Income  Account 

1.  Gross  Earnings  per  mile 

2.  Operating  Expenses 

(a)  Transportation  Expense 

1.  Past  Record 

2.  Rates 

\b)   Maintenance  Expenses 

L  Maintenance  of  Way  per  mile 

2.  Maintenance  of  Equipment  per  unit 

3.  Net  Income 

4.  Fixed  Charges 

(a)  Per  mile 

(b)  Relation  to  Gross  Earnings 

(c)  Relation  to  Surplus  Remaining 

5.  Surplus  for  Dividends 

(a)  Per  cent  of  Gross 

(b)  Relation  to  Dividends  Paid 


APPENDIX  III 

KEY    PRORLEM    ON    RAILROAD    INVESTMENT 

Relative  to  consideration  of  Railroad   Earnings  reports 

This  key  problem  is  presented  to  show  that  Hltle  weight 
should  be  given  the  simple  statement  that  fixed  charges  are 
covered  twice  or  two  and  a  half  times  over.  In  considering 
a  railroad  investment,  further  investigation  is  abolutely  neces- 
sary. 

TAKE  TWO  RAILROADS  —  RAILROAD  'A" 
AND  RAILROAD  "B" 

Gross  earnings  of  both  for  the  year  have  been  $10,000,000. 
In  both  cases,  fixed  charges  have  been  earned  twice  over.  The 
fixed  charges  for  *A,"  however,  are  $2,000,000  a  year  against 
$1,000,000  for  Railroad  "B."  It  can  thus  be  seen  that  in 
Railroad  'A,"  the  ratio  of  fixed  charges  to  gross  revenue  is  20% 
while  in  Railroad  "B"  it  is  only  10%. 

The  ratio  of  fixed  charges  to  operating  expenses  in  Railroad 
'A"  is  33^%.  The  ratio  of  fixed  charges  to  operating  expenses 
for  Railroad  "B"  is  12^%. 

Could  both  these  roads  stand  a  reduction  of  lO':^  in  gross 
earnings,  given  fixed  operating  expenses,  and  still  continue  to 
cover  fixed  charges.-'     If  not,  can  one?     Which  one? 

After  having  decided  in  your  own  mind  from  the  figures  given 
above,  actually  subtract  10%  from  the  gross  earnings  of  each. 
On  the  basis  that  operating  expenses  as  outlined  above,  and  as 
figured  from  the  ratio  of  fixed  charges,  remain  constant,  find 
net  income  available  for  fixed  charges.     What  is  the  result? 

This  problem  clearly  shows  that  neither  the  ratio  of  fixed 
charges  to  net  income  or  the  ratio  of  charges  to  gross  revenue  is 
sufificient  to  determine  the  safetv  of  a  railroad  bond  in\'estment. 


Garden  City  Press,  Inc. 
Newton,  Mass. 


I'Auvaaii  3*' 


JilJJNV-^iUI-^ 


'^/^a3AiNn-3^v 


^<5Aavaan•i^^1 


■  5MEllNIVER5y>,         .vlfKAWfJfJ^r. 


.atJlDDAI»(frj. 


L2: 

P5 


University  of  California 

SOUTHERN  REGIONAL  LIBRARY  FACILITY 

305  De  Neve  Drive  -  Parking  Lot  17  •  Box  951388 

LOS  ANGELES,  CALIFORNIA  90095-1388 

Return  thiis  material  to  the  library  from  which  it  was  borrowed. 


C71DNVS01^         ^/^a^AINOJWV 


:5r 


*i^«  « 


m  m 


^^OAWMWl"^ 


^^oxHymn"^ 


Mwwm//} 


"^mmiov^ 


MMims// 


'^(i/OJIlVO-JO^ 


^•OFCAJlFOfti^. 


^^Aiivaaii-i>J^ 


^MfUNIVER% 


c~>  S2 


^TilJQNVSOl^ 


'^RY^/\        ^vMllBRARYQ^ 


.<.OFCAIIFO/?^. 


,\WEl]NIVER5-//, 


o 


A\\EUNIVFR.V/A 


^lOSANCElfj>. 

o  ^^ ^  ^ 


%a3AiNnjv\N^ 


.in<:Aijr.Fifr. 


•v^vSllIBRARYd?/- 


^«!/0JITV3JO'i^ 


UC  SOUTHERN  REGIONAL  L;BRARY  f  AClLITy.,, 

'iiiiiiiinii!|i!iiiiii;iiiiiii:;M||i!i  il'l!!  i'li'li  I 


AA    000  977  888    7 


A 


of  California 
Regional 
Facility 


